"Much of the world is going through a downswing of the credit cycle. Argentina doesn't have and didn't have much credit. So it will be spared the big problems. But it sells farm produce to the rest of the world. It has to expect a period of sluggish sales and soft prices.

"I don't know if I would advise foreigners to bring their money to Argentina. But I would advise everyone to diversify beyond their home country - especially if they are American or British. Generally speaking, it appears that the go-go finance-based economies of the Anglo-Saxon world have peaked out. They lived on credit. Now, they die on credit. And they will find it very hard to shift their economies from credit-fueled consumption to investment-driven production and export. The competition is too stiff. America is a high cost producer. It can't compete easily with the developing and emerging economies. So, it will just have to get used to a lower standard of living. That means lower asset prices too. Which is why an investor - broadly speaking - can anticipate a higher rate of return from his investments in India, Brazil and even Argentina, over the next 20 years, than he can from the US."

But isn't Argentina full of crooks, booty-shaking tango dancers, escaped Nazis and Norteamericanos on the lam?

A friend of ours thought so. She was having lunch at a nice restaurant in La Recoleta, one of the nicest parts of town, when someone stole her purse. Poor thing, we were afraid her trip was ruined. But then, she got this email:

"Hi good afternoon, my name is Emiliano, is that i work doing maintenance of parks and squares in the area of palermo, and in one of the trash bins encontre a series of documentation to its name and among other things i could detect this mail.

"That is why i warn that i have the papers mentioned, licenses, passports, credit cards, etc. without more and in anticipation of any response on their side and wishing you are with their belongings, i leave my mobile Phone in order to combine a meeting so that you can restore their belongings, but more, i dismissal of you carefully."

She writes: "This 'Santo Emiliano' is now and always will be the patron saint of Buenos Aires. He has restored my faith in humanity by going beyond his job tidying up the beautiful local parks and helping a total stranger to once again see the real beauty of his city. He explained that he enlisted the help of many friends to compose the email above. I get teary-eyed thinking about it. I can't wait to meet him and try to explain to him in my broken 'castellano' that he is working in the wrong municipal department and should be promoted to the head of the department of tourism!

"Ah, the world is once again a nice place to live."

And lastly...

"I must say," Elizabeth began, after hanging up the phone. "Being married into your family is an enriching experience."

Elizabeth comes from a good New York family. Her ancestors were ambassadors, officers in Washington's army, heiresses and socialites. She went to private schools and then to an Ivy League university. Poor thing. She had never had much contact with Irish riff-raff, tobacco road farmers, and lowlife financial publishers. She can thank your editor for introducing her.

She had just been talking with one of our cousins. Well, the wife of a cousin who died suddenly last week. He was only in his 50s and seemed like a nice enough fellow. But he was no Harvard-trained go-getter.

"I felt so sorry for her [the widow]," Elizabeth continued. "Your cousin hadn't worked in years. He was on disability. I'm not sure what that is. Some sort of welfare, I guess. He didn't look disabled when we met him two years ago. He was such a big, strong man.

"But when he died, he left his wife with no source of income at all. She's applying for disability too. She has no income at all. I don't think they have any savings either. And her disability status hasn't been approved yet. It hasn't come through. I wanted to tell her that we'd help her but I felt a little awkward. I've only met them a few times. You should do something...

"There is a whole world out there that I didn't know anything about...that lives and thinks in a much different way than we did. They're very nice. I like all your family. But they have very different attitudes and habits than what I'm used to. I wonder what caused it. Maybe they probably worked hard when the steel mills were operating. But then, when the mills shut down, maybe they got in the habit of getting paid not to work. I don't know...but it's very strange."

"What do you mean," was our reply. "Your family didn't work for generations. They inherited wealth and spent it. They spent money they didn't earn. My family did the same thing. They just spent wealth from other families...and didn't get as much of it."

Until next time,

Bill Bonner
for The Daily Reckoning Australia

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The $2.5 billion listing of Myer is expected this week. And what better way to celebrate a six-month reality-defying rally than the listing of a consumer-driven business? Happy days are here again!

Not that we have anything against Myer. It's a good store. We recently bought a sweater there to get us through Melbourne's Antarctic spring. But you know our position here at the Daily Reckoning.

You don't wash out twenty years of mis-allocated credit with a mild recession and then return to the glory days of the stock market. We are still in the middle of a large deflation in credit-backed financial assets. The Myer listing may give the index a boost. But it's not going to change the big picture.

The big picture is that across the Western world consumers are dialing back the spending and turning up the caution. A sea change in attitudes about the future is taking place. For example, the U.S. Commerce Department reported that durable goods orders fell in August by 2.4%. Take away government subsidies for new cars and households are not buying big ticket items.

And then there's housing. Existing home sales fell by 2.4%, the first decline in five months. Here's a warning: watch out for a second massive wave of foreclosures in U.S. housing. U.S. banks, thanks to a relaxation of mark to market accounting rules, have been able to put off the day of reckoning on what to do with millions of non-performing loans. That day, though, is coming.

There are other looming issues like commercial real estate. But we know you must be tired of hearing all that. After all, that is America, not Australia. It would be much easier if we quoted the impossibly smug Kevin Rudd that the government has saved the day. But that just ain't the case.

By our reckoning, the second dip of the global downturn is upon us. Government policy (monetary and fiscal) has merely lured people into believing there is no real cost for decades of bad investments. But the truth is that a lot of stock analysts and economists have simply miscalculated the magnitude and severity of what happens to the real economy when the world's largest ever credit bubble bursts.

Of course we could be wrong. Nobody knows what's going to happen. You hedge your bets and continue to plan for the future. But we're about to find out if we've been living through a modern version of 1930, when a false recovery in the economy was the prelude to the "Great" part of the "Great Depression."

Maybe this will sound like a bunch of whining by the end of the week. After all, three of the big four Aussie banks will report results this week. There will be billion dollar cash profit figures tossed around. But as we said last week, the earnings performance of financial firms in the last six months is a sham.

Cost cutting, government loan guarantees, and an infusion of central bank credit allowed all the big financial players to trade their way to profits for a few quarters. What we don't expect to see is that the Australian banks are suddenly keen to expand their loan books or that their underlying businesses are fundamentally better now than they were twelve months ago. A simple question: just where will the profits come from now?

In the meantime, keep an eye on oil. Sometimes the oil price is driven by speculators. Sometimes it's driven by expectations for the economy. And sometimes it's driven by flat out geopolitical fear. We think now could be one of those times were geopolitics drives crude. Why?

We got a note from a commodities trader in Chicago over the weekend. Up at three a.m. as we're getting over our jet leg we read, "In the big geopolitical dance that has dominated recent headlines there remains one player that all the action seems to swirl around. That player is Iran.

"President Obama's announcement of the discovery of a second 'secret' uranium processing facility with shouting distance of the Shiite holy city of Qum has raised the stakes in what is quickly becoming a very dangerous game. If you read between the lines, nearly all of the geopolitical maneuvering over the past few months has been about the same thing.

"Obama dumps Bush's land-based missile system for a sea-based one that poses far less threat to Russia. Russia - without admitting it, of course - then becomes more accommodating to sanctions against Iran. Israeli Prime Minister Netanyahu goes to Russia without telling anybody and gets caught doing it. Why?

"Certainly not to talk about the weather. We believe Netanyahu was there for a specific purpose: to warn Russia what would happen if Iran did not stop producing bomb-grade uranium. We also believe Obama's controversial move was designed to give Russia political cover to pressure Iran to do just that. Now that a second uranium-producing facility has been found, the stakes have risen again.

"If some sort of political solution to the Iran crisis is not found within the next few months, Israel will strike - with or without the 'permission' of the United States and the price of oil will react accordingly. The global slowdown is currently focusing all the attention on demand, but the biggest bullish factor out there is ultimately, supply. Remove Iranian oil from the market and the old highs of $147 per barrel could be tested quickly.

"Is this going to happen? We hope not. However, our read of the geopolitical events of the past few months makes us think it could be a distinct possibility.

Dan Denning
for The Daily Reckoning Australia

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And when we ran out of money, no problem! There was more where that came from. In one sense we couldn't spend money fast enough. As soon as it was gone, there was more suddenly available. So we just finance the house again, take out some equity (which always rises) and do one of two things - Pay off credit cards (so we can load more debt on them) or just spend the cash on things a home improvement (that is no longer reflected in the price of the home) or a vacation.

Remember how MasterCard taught us that those memories were priceless? Hope you got some good ones... because you "done bought something you can't eat," as one of my teachers used to say.

At a time when we are drowning in debt, we are also out of money.

When a debtor is out of money, he has no ability to repay. And when a creditor has borrowers who are out of money, the creditor has no income. No earnings. No power to make better loans.

So how are banks in America posting "profits"? How did Citigroup, Bank of America, AIG and Wells Fargo jump 400% in stock price? Are they worth 400% more? Are their earnings up 400%? And where in the world did all this money come from?

These companies were just bankrupt... yet found a way to get back above water. And not just above water - they are making moon-shots!

Their share price should be zero (or less, if possible!). How are they worth so much more now?

As I have written before, mark-to-market accounting rules were repealed in favor of a fictitious slight of hand. Banks no longer have to list their distressed assets at the fire sale price they should be worth. Instead they get to record their value as the price they bought them, or what they believe they will be worth in the future.

In other words, it's like me refinancing my house, but doing my own appraisal and assigning it whatever value suits me. I want cash out? Just pad the value of the house. I can't afford a higher payment? No worries, I just pad my reported income. Two years down the road I can't afford my payments anymore? Easy, just follow the same refinancing procedure all over again.

But my family and I would only have one toxic asset to deal with. The banks have them coming out the wazoo!

They are still in possession of the faulty loans and derivatives that caused this entire mess in the first place. Nothing has changed - except the accounting!

The banks always counted on that. This time, however, they are the ones left holding the bag. What are they going to do with all this JUNK? How can they unload it without attracting suspicion? How can they clean up their books without the short sellers making a profit off their downfall? They can't. It's a Catch-22.

But the real problem is that the US banking system would come crashing down in a minute if this were known and understood by the general public. The banks know it. The Fed knows it. I suspect that there are some congress people who know it.

But here's where the rubber meets the road. Government engineered a bailout. They wanted the banks to lend to Joe Consumer. But the banks didn't. And frankly, Joe Consumer didn't want it. He was too busy trying to figure out how he was going to repay all the money he had already borrowed against his house. Especially with the boss breathing down his neck, threatening job terminations if he wasn't more productive than some cheap labor in India.

So the banks were sitting on a good deal of the money from the Fed in order to protect them from future losses. Some of them have even paid it back. But the truth is, from an accounting standpoint, they don't need it anymore. From an accounting standpoint, their mortgages and derivatives are all valued at a big fat surplus. Why keep federal money? Why incur interest charges when "all is well"?

If they can show a profit from an accounting standpoint... and if they can repay their bailout money (plus interest)... and if they can still service the customer at the drive-in window or the teller counter, what's the big deal? What am I crying about?

It's all because those toxicities still exist. And they all have to be accounted for, whether the government says so or not.

We should have learned, or have been reminded of, one of the greatest lessons in the world from convicted felon Bernie Madoff: "Be sure your sin will find you out."

Even the greatest engineered schemes on the planet come undone at some point. No Ponzi scheme can continue forever. But if you are very bright (as Madoff was), you can keep the game going for a long, long time.

But what if you're not brilliant? After all, I doubt the government is as smart as Billionaire Bernie. Luckily, if that's the right word, the government has another way to keep the game going, using one thing it has that Madoff didn't.

Cash.

Gobs and gobs of it.

The government's massive wad of cash is what keeps the game going. And foreign investors lending us money. And millions of pensioners happy as long as they receive their check on the first of the month. And the multitudes of purchased votes that are blissfully sitting on the dole.

But it's not just the United States. Every country in the world is in the same pickle - because every developed nation believed they could successfully manipulate the game. The problem now is that the governments are running out of money. The United States has been broke for a long time, of course, but it could still trade on the value of its good name... and it did. Other nations are not so lucky.

The United States still possesses the reserve currency status; other nations aren't so lucky. We still boast the largest GDP; other nations are not so lucky. I'm pretty sure we still have higher tax receipts, and more room to raise taxes than other nations. But somehow, I can't bring myself to call that lucky...

But as it is an "option," I have to think that whatever smarts our government does have, someone will eventually realize it. Good Lord, deliver us.

I do not honestly think that anyone can seriously contest us in the role of reserve currency, no matter how many times China rattles the saber.

Twenty years ago, China couldn't even feed its own people or keep them employed. Now it is boasting a 7% annual growth rate. Despite the massaging that may be done to the numbers before they are released, we can already see that a country growing solely on stimulus cannot grow very long. The weaknesses in China's underbelly are already becoming apparent. She is an export economy. And people are not buying.

She cannot save the world, whatever her strength might be.

There is another round of destruction coming. The banks will have to come clean. If you thought the residential crunch was stunning, wait till you see what's coming on the commercial front. It will be a tsunami of epic proportions. Banks are not lending now, and the chances of business expansion are lower than at any time in recent history. No one will be buying excess of anything except maybe food and precious metals, so businesses will not continue to post profits. Without profits you can't service the loans you have, and rolling them over will be out of the question. The day is coming... don't let it catch you by surprise.

But until that day arrives, we must deal with what we have.

Regards,

Bill Jenkins
for The Daily Reckoning Australia

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The burden of today's Daily Reckoning, then, is to remind these nattering nabobs of negativism that gold is not anyone else's debt. It is not anyone else's liability. It cannot be created with a few keystrokes. And for thousands of years, millions of people from all walks of life have been happy to use it as money because of its unique features (divisibility, durability, scarcity, difficulty in counterfeiting).

Gold is a commodity. But its price is not driven exclusively by the Indian jewellery market or investment demand. As a tangible commodity, gold has some of the aforementioned qualities that make it a fantastic medium of exchange.

And for people who trot out the canard that you can't buy a Big Mac with gold coins, what do you think goldsmith's notes were? They were receipts that indicated gold ownership and your ability to pay a debt. You could exchange goldsmith's notes as payment for goods and services because the paper claim was backed by a real asset. Goldsmith's notes were the precursor to bank notes. Same type of system, but with real money.

Is this all just some nostalgia for a financial system that no longer exists? Does gold have a real role to play in the future financial system? Of course it does! Gold is a threat to the fiat money peddlers from the warfare/welfare State because it exacts a heavy price for deficit spending and money creation. The expansion of credit or deficit spending is always possible in a fiat money system and thus placates voters with false prosperity borrowed from the future.

The rise in the gold price is telling us that markets are increasingly suspicious of the government-backed money and its ultimate affect on the real economy. Or, as guest essayist Greg Canavan says, " Gold is saying that the crisis is not over, that it is in fact getting worse. We are seeing Gresham's Law in action, as bad money pushes out the good. Gold is being swept off the market by millions of individuals who know that without fail governments always ruin the value of their paper money."

The only real - albeit shallow - criticism of the gold story is that it's primarily a U.S. dollar story. For Aussie investors, a collapsing greenback doesn't equate to a higher Aussie-dollar gold price. We would say, though, that this is a short-sighted appreciation of what gold is saying about the modern money system.

The modern money system is built on credit, debt, and government money backed by nothing. To believe that does not mean you'd covert all your assets to bullion, or all your shares to gold stocks. But it IS to believe that the architects of this system are criminals who effectively steal your wealth through inflation and control of the money supply.

If you have confidence in that system, you're a sucker. And if you don't hedge against its collapse, you're unprepared. After the last two years, is it so farfetched to believe that the foundations of financial capitalism - based on unsound money as they are - are weak by design and will fail in a world of increasing complexity and interconnectedness?

If you don't think it could happen, you haven't been living on Planet Earth. Either that or you're in a business where you want everyone to go back to doing what they were doing pre-Lehman collapse because it's good for your business. If that's the case, it's fine. But it's foolish to ignore 5,000 years of monetary history.

Yesterday we wrote about what happens when a complex network of trade and commerce begins to shrink as credit is withdrawn from the global system. Another side effect of the Lehman collapse is a bear market in trust. Trade, once free flowing and robust, becomes politicised. Trading partners begin to bicker.

Take Barack Obama's decision to slap a large import tariff on tyres made in China. It will probably just drive up the cost of cheap tires of middle-income Americans. But it makes America's unions happy, and Obama needs them to push through his health care agenda. China has responded with warnings about possible tariffs on U.S. poultry and auto parts exports.

It's probably not in neither country's economic interests to get in a trade war. But it reflects the ambiguity and hypocrisy of trade practices by both countries. There is no such thing as free trade. China subsidises production with cheap labour and produces at below production cost for some goods and services. America is happy to lose those manufacturing jobs if American shoppers get lower prices and have access to credit to make up for falling real wages.

But that whole strange relationship that has driven global growth for the last ten years has reached its use-by date. We're not sure what's going to replace it. But both parties are guilty of being currency manipulators and subsidisers. Formerly, their interests were aligned. Now, it's not so clear.

And finally a note from JL in Queensland about networks, nodes, and certain monetary commodities.

"Just my two cents worth. The difference between a node in a computer network vs. a node in the financial/economic system is that the node in the network can be self sustaining (provided that it's plugged in to electricity), whereas, most of the nodes in the financial/economic system are NOT self sustaining.

"The ONLY financial/economic node that would be self-sustaining and immune from ALL shocks (i.e. Exhibit the financial equivalent of homeostasis) is one that is 100% backed by a financial asset which is no one's liability. I'll leave you to guess what THAT financial asset may be.

Dan Denning
for The Daily Reckoning Australia

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"Always liked Bedford Springs. A resort to presidents going far back into the early days of the republic (you know... 'A republic, if you can keep it.')

"My dad used to go there quite a bit. The Pennsylvania Bar Association hosted its annual meeting at Bedford Springs for many decades. And my dad used to do very well in the golf tournament. So he'd schmooze with the judges, and win at golf...you got a problem with that?

"Delightful mountain retreat, really. An escape from the bad air and worse sanitation of old east coast cities. A necessary water stop on the Pennsylvania Railroad. Giant old building, with many a fine room - those walls have some stories to tell, I'll bet. And those elegant balconies? Ah, from there you can catch the cool breezes falling off the nearby hillsides.

"Time was unkind to the hotel, however. Oh, what a wreck and ruin the place was by the mid-1980s and through the 1990s. Time passed it by. It was built for a steam railway age, when horses and carriages would lug the guests and baggage up from the train station for lengthy stays. People would 'summer at the Springs.'

"By the modern era, people didn't need some old-fashioned mountain resort. They wanted to get into jet airplanes and fly off to some coastal port-city, thence to board giant cruise ships or the like. Take their vacations riding the waves in 'don't spill the drinks' comfort. All while visiting some island du jour, where they speak English with funny accents.

"Really, who needed Bedford Springs so long as the world offered cheap credit and cheap energy?

"Still, someone must have realized that Bedford Springs is irreplaceable. They just don't build 'em like that anymore. So the place underwent a superior renovation about 10 years back. Now it's a luxury resort...beautiful job. But in a world of tightening credit? Hmmm...it's a luxury resort, 'if you can keep it,' to coin a phrase.

"Thus Bedford Springs still has to compete hard in this tough economy. From what I know, it hosts many a wedding and a few business meetings - its advantage is that it lacks the federalized stigma of other resort locales like Las Vegas. But it has yet to make it in a big way into the public consciousness.

"Still, it's right off the Pennsylvania Turnpike. So for the price of half a tank of gas, you can get there from Pittsburgh or Philadelphia, Washington or Baltimore...and within a three hour drive or so. So geographically, it's a good place for an era of tighter credit and more expensive energy.

"Plus, it's on the dry land of the Keystone State. It's a fixture, with deep foundations and good old bones.

"When the Chinese have long since repossessed the encumbered airliners and cruise ships, they might have some trouble seizing and shipping home the likes of Bedford Springs.

Who knows? The American economy may yet dig in, and its last ditch will be along Route 30 near Bedford Springs. 'This far shall you advance, oh you creditors and claimants, and no further.'

"Bedford Springs...what a great old piece of Americana."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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Let's review our own narrative: deflation now, inflation later.

It's very simple. Maybe too simple. After a half a century of credit expansion, we now have a credit contraction. In this sense, everything is happening as it should.

There was a crash and credit crunch at the end of last year. Then, the feds panicked. They fought back with monetary and fiscal stimulus. Rates were cut to nearly zero. The Fed flooded the system with cash and easy credit - buying up Wall Street's bad investments...propping up bad banks...and guaranteeing trillions worth of bad debt. And the federal government passed a stimulus program that authorized more than $700 billion in spending.

Beginning on March 9th, we also got a big bounce in the world's stock markets - just as we should. US stocks are up about 40% since then. Some foreign markets are up even more. Russian stocks, for example, have more than doubled. Chinese stocks are up more than 60%.

As the bounce continued, people began to get the wrong idea. They thought they saw 'green shoots' and the 'light at the end of the tunnel.' But if the economy is really improving, we haven't seen much evidence of it here at The Daily Reckoning headquarters. As near as we can tell, housing prices are still going down and unemployment is still going up...and most important...people are still acting as though we were on the downward slope of the credit cycle. The latest numbers we've seen show that they saved more money in the first half of the year than the total in extra 'stimulus' that they received. Savings - last reported at 5% in this space - are now close to 7%. This is a just what you'd expect. But it is a huge turnaround, too.

As to housing prices, there are a million option ARMs still to be reset over the next four years. They won't peak out until 2011...with average increases of about 80%. That will cause hundreds of thousands more houses to be dumped onto the market...and probably push the bottom of the housing decline to 2012.

As long as housing prices are falling, jobs are declining, and consumers are inclined to save rather than spend, there will be no real recovery.

In our book, recovery is impossible anyway. Because the pre-crisis economy had reached the terminal stages of the credit cycle. It was like someone in the terminal stages of a fatal illness. After they have died, you don't wish that they could recover...and be just like they were before they died. They were sick and dying then! No, you sign the book of memories and condolences and turn the page. You let new life take the place of the dead. You move on.

But the feds have their ghoulish agenda. They have the poor thing on life-support. One tube feeds the oxygen of easy credit. Another drips in more 'stimulus.' The economy rattles every time it breathes. Dead companies, such as GM, say they are reborn. But take away the tubes...and they collapse. Dead-in-the-water households learn to live submerged in debt ...with special tubes provided by the feds - such as the underwater mortgage refinancing offered by Fannie and Freddie, where homeowners can get up to 125% of the value of their houses. And the brain dead economists at the Fed and the Treasury department continue to offer their elixirs and panaceas - even though they have never worked.

Everything is happening as it should, in other words. But what happens next?

Ah...this is where it gets tough. Because we're losing our faith. We figured the economy would continue to worsen (after all, you can't correct a half-century credit expansion in a few months)...and that the feds would continue to fight it. As more and more people lose their jobs, the feds would become more and more desperate. Gradually, they'd come to see that they needed to use stronger, more experimental techniques. This would lead them to be a bit bolder with their 'quantitative easing,' otherwise known as "a little technology called the printing press," to quote Ben Bernanke.

We figured that sooner or later, the feds would get the hang of causing inflation. So, we could just buy gold and wait.

But now we see; we are trapped...just like the feds themselves. Do we hedge against further economic deterioration... deflation... and falling asset prices? Or do we hedge against inflation...a falling dollar...and a collapsing bond market? What if we hold our big position in gold...and feds NEVER are able to cause inflation? What if the pain of the depression is never severe enough to make them go whole hog on quantitative easing? What if the Chinese put it to them straight: if M2 goes up more than 10% a year...we stop financing your deficits? Gold could sink...or go nowhere...for the next 10 years.

Are we prepared to sit it out...? It's time to go back to the pub...

This morning our thoughts turn to Goldman.

The news yesterday told us that Goldman execs paid themselves $700 million in bonuses - while receiving bailout money. This morning, stocks in Asia are rising; they say it's because Goldman had a good quarter - wiping out its loss from the last quarter of last year...

The news:

"Goldman Sachs reported second quarter earnings of $2.72 billion, up on last year's $2.05 billion, and easily surpassing forecasts thanks to big gains in trading and underwriting."

The New York Times offers more details:

"Analysts estimate that the bank will set aside enough money to pay a total of $18 billion in compensation and benefits this year to its 28,000 employees, or more than $600,000 an employee. Top producers stand to earn millions.

"Goldman Sachs is betting on the markets, but the markets are also betting on Goldman: Its share price has soared 68 percent this year, closing at $141.87 on Friday. The stock is still well off its record high of $250.70, reached in 2007.

"In essence, Goldman has managed to do again what it has always done so well: embrace risks that its rivals feared to take and, for the most part, manage those risks better than its rivals dreamed possible.

"For all its success, Goldman is not impregnable. In addition to the federal money it took last fall, it benefited from the government's bailout of the American International Group, being paid 100 cents on the dollar for its $13 billion counterparty exposure to the insurer, and it has $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corporation."

Not everybody likes a winner. There are some who think there is something underhanded and un-American about how Goldman does business. Making billions trading bonds? It is almost as if they knew better than anyone else what the feds would do next. Maybe they do.

The DR Australia's Dan Denning offers his two cents on the subject:

"We'd suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America." Furthermore, Denning points out, most other American financial institutions are continuing to play "hide the bad asset."

"A New York Times story suggests that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble.

"'The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,' says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. 'It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.'

"This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now," Denning continues. "The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they'd get a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent)...

"The default and foreclosure data coming out of the US housing market suggest the banks are kidding themselves, or misleading shareholders, or both!" says Denning. "It's the sort of calculated mistruth that can cause a short-term crisis to last years and years. The correction is postponed through phony accounting. It leads to an 'Ushinawareta Junene,' or 'lost decade,' as the Japanese say."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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• Feds’ Plan is to Reflate the Economy
• Economy Free to Recover?
• Level 3 Assets Growing in All Five U.S. Investment Banks

This is the shift we've been talking about for months. The great credit expansion of 1945-2007 is over. Now cometh the great credit contraction.

During the bubble years, more and more credit produced less and less real prosperity. It was as if you were borrowing more and more, to invest in your business or merely to increase your standard of living, but your income didn't rise fast enough to keep up with the interest payments.

In 2005, Americans saved nothing. Not even aluminum foil or string. Now, the savings rate is approaching 5% of disposable income - a big turnaround.

We know from logic and experience that saving money - not spending it - is the key to getting wealthier. Saving money gives you capital. And it's capital accumulation - in the form of factories, roads, ships, buildings, machines...and raw savings - that gives people the ability to produce more. It may take a man with a shovel a whole day to dig a decent grave. Give him capital - in the form of a backhoe - and he can bury everyone in town. That's why capitalism works. It rewards the fellow who saves his money.

Yet every yahoo economist in the year of our Lord 2009 takes news of rising savings rates like the death of Michael Jackson. If households don't consume, they reason, how can a consumer economy grow?

The problem is that you can't really grow an economy by borrowing and spending.

Recent history proves it. Despite the biggest splurge of borrowing and spending in history, the US consumer economy barely grew at all.

"In the five years to December 2007," reports Grant's Interest Rate Observer, "America's credit market debt climbed by nearly 57%, to $18 trillion. However, in the same half-decade, nominal GDP was up by only $3.3 trillion."

For every five dollars people borrowed, they only increased their incomes by $1. Imagine that the borrowing had an average effective interest rate of 10% (credit card debt can be much more expensive). At that rate half of the additional income earned between 2002 and 2007 had to be used just to pay the interest.

This was not the kind of growth that was likely to last. In fact, it didn't. The whole thing came crashing down in '07 and '08. And now, the consumer has had a cup of coffee. He's looked at himself in the mirror. He's sorted through his pile of bills. And he's made up his mind: that's enough of that!

"The ratio of cash held by households as compared with assets has been rising sharply," says James Saft in The New York Times.

"Companies, households and banks all want to pay down debt and...prefer to hold cash rather than assets, partly because the outlook for those assets is poor and partly because after a decade of excess, everyone now looks a bit over-extended.

"This is exactly what happened in Japan during its lost decade, when a balance sheet recession, one characterized by the paying down of debt and liquidations of assets, was self-reinforcing and very difficult to stem."

And now this from David Rosenberg:

"The ultimate question is where all this cash is going to be deployed, and we believe it will ultimately be diverted toward debt repayment."

Let's see. We can figure this out from the numbers above. American consumers must have added about $7 trillion in extra debt during the Bubble Epoque, 2002-2007. Now, instead of buying things, they use their money to pay it down. The average household has about $43,000 worth of income. Let's keep the math simple by saying there are 100 million households in the United States...and that they save 5% of their income. And let's say they use every penny of savings to pay down debt. Hey...it will only take about 30 years to pay it off! Get ready for a long, long slump.

Bill Bonner
for The Daily Reckoning Australia

• Consumer Spending Rises
• Aussie Dollar is Crushing Long-time Rivals Like the Pound and the U.S. Dollar
• Future Fund ‘Borrowing’ Program Amounts to Theft
• Why I Would Have Raised the Interest Rates
• It Would Take About 19 Years to Erase Debt From Bubble Period

For now, the "bottom" is in - that is, the bottom of this society's ability to process reality. It may continue for a month or so, but events are underway that are beyond the command of personalities. We're done "doing business" in all the ways that we've been used to, but we just can't get with the new program. Let's count the ways:

1. The revolving credit economy is over. It's over because we can't increase energy inputs to the system, which is one way of saying "peak oil." Of course hardly anybody believes this right now because the price of oil crashed nine months ago, along with global manufacturing and trade. But nothing has changed on the peak oil scene - except perhaps that ever more new oil projects have been cancelled for lack of financing, which will boomerang on us (even if swine flu doesn't) in the form of much lower future oil production. In any case, the credit fiesta is over, and the "consumer" economy with it, because industrial growth as we have known it is over. It's over globally, too, though all regions of the world will not experience its demise the same way at the same rate.

The Asian nations may swap things around a while longer but China is basically up the creek without a paddle. They have less oil left than we have (which is saying, not much at all) and they won't corner the rest of the global oil market without starting World War Three. Meanwhile, they're running out of water and food. Good luck becoming the next global hegemon. Oh, and Japan imports 90 percent of its energy; India over 80 percent. Fuggeddabowdit.

Credit will not vanish everywhere overnight - even in the U.S.A. - because it is not distributed equally everywhere. But it will vanish in layers, and here in the U.S.A. a very broad layer of the lower and middle classes are now losing their access to it in one way or another - personally, in small business - and they will never get it back. Anyone who intends to thrive in the years just ahead had better plan on doing it on the basis of accounts receivable - and what they receive might not even necessarily come in the form of U.S. dollars. It may come in the form of gold or silver or in the promise of reciprocal services rendered.

This has enormous implications for two of the items in which our credit-dispensing operations are most deeply vested: houses and cars. Unfortunately, these are exactly the things that economic life has been based on for decades in our nation, which leads to the next categories:

2. The suburban living arrangement is over, along with all its accessories and furnishings. Taken as "all of a piece," the suburban expansion was one sixty-year-long culmination of hypertrophy. We did it because we could. We won a world war and threw a party. We had lots of cheap land and cheap oil. It made lots of people lots of money and all its usufructs have become embedded in our national identity to the dangerous degree that the loss of them will provoke a kind of national psychotic breakdown. In fact, it already has. The completely unrealistic expectation that we can resume this way of life is proof of it.

The immediate problem is that we can't build anymore of it. The next problem will be the failure of the stuff that already exists. The first stage of that is now palpable in the mortgage foreclosure fiasco and, just beginning now, the tanking of malls, strip centers, office parks and other commercial property investments. The latter will accelerate and become visible very quickly as retail tenants bug out and weeds start growing where the Chryslers and Pontiacs once parked. The next stage, which involves large demographic shifts in how we inhabit the landscape, has not quite gotten underway.

3. The Happy Motoring fiesta is over. You'd think that with Chrysler crawling into the bankruptcy court, and GM just weeks away from the same terminal ceremony, the news media would begin to suspect that the foundation of everyday life in this country was cracking. Instead, all we hear is blather about "market share" shifting to Toyota. News flash: not only will we make fewer automobiles in the U.S.A., but Americans will buy far fewer cars made anywhere. We'll keep the current fleet moving a while longer, but when it's too beat to repair, we won't be changing it out for a new fleet - despite all the fantasies about hybrids, plug-and-drive electrics, and so on. The masses will be too broke to buy these things. What's more, they will be very resentful of the shrinking economic "elite" who can afford them. And, anyway, our roads and highways are destined to fall apart very quickly because there is no way we can sustain the necessary rate of normal maintenance. Meanwhile, we remain completely un-serious about public transit - even about fixing the vestiges that still exist. The airline industry, of course, will be toast inside of five years.

4. Our food production system is approaching crisis. There's no way we can continue the petro-agriculture system of farming and the Cheez Doodle and Pepsi Cola diet that it services. The public is absolutely zombified in the face of this problem - perhaps a result of the diet itself. President Obama and Ag Secretary Vilsack have not given a hint that they understand the gravity of the situation. It is probably one of those unfortunate events of history that can only impress a society in the form of a crisis. It also happens to be one of the few problems we face that public policy could affect sharply and broadly - if we underwrote the reactivation of smaller, local farm operations instead of shoveling money to giant "agribusiness" (or Citibank, or Goldman Sachs, or AIG...). I maintain that this may be the year that the crisis gets our attention, because capital is suddenly harder to get than fossil-fuel-based fertilizer.

All these epochal discontinuities present themselves, for the moment, as a season of muted "hope" and general apathy. The days are suddenly mild. We've resumed old and happy habits of grilling meat outdoors and motoring to those remaining places that were not blanketed with franchised food huts and discount malls. We have a new, charming president with an appealing family. Newly-minted dollars are flowing to the "shovel-ready." The new bad news is less bad than the old bad news (or seems to be). And the year just past has been such a bummer that our hard-wired human nature tells us that good things must be just around the corner.

Personally, I think a lot of good things await us, but not the ones we're expecting - not a return to buying Slurpees on credit cards. It will be very salutary to leave behind the junk empire we've accumulated and move into an epoch of quality and purpose. For the moment, though, our hopes reside elsewhere.

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

• The Empty Nest Stage: Henry is Going to the University of Virginia
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• Cash for Clunkers Cars
• A Recovery of Some Kind in Global Trade

Readers are reminded of our Daily Reckoning Law: 'The force of a correction is equal and opposite to the deception that preceded it.' Today, we offer a corollary: 'The greatness of a depression is commensurate to the government's efforts to prevent it.'

Since these iron laws seem to contradict almost everything one hears on the subject, the burden of proof is on us. So, to the witness stand, we call our first expert, Angela Merkel. Alone among the world leaders, she seems to have kept her head:

"The crisis did not come about because we issued too little money but because we created economic growth with too much money, and it was not sustainable," explains Germany's chancellor. She went on to suggest that maybe we shouldn't repeat the errors of the past.

As a proxy for 'deception' in our handy dictum, substitute 'money.' And now consider it in its two misleading forms - credit and deficit spending. "Credit not backed by real savings is a fraud," the great economist, Kurt Richebächer, used to say. It is a fraud when it comes not from willing lenders, but from central banks, artificially reducing lending rates in order to spur the economy. Deficit spending by government is a flimflam too. Governments rarely have extra funds to spare; they have to borrow the money. Eventually, that debt will have to be paid.

During the entire last half a century leading Western economists imagined a world that couldn't exist for one minute - where consuming wealth makes people wealthier...and where simply making more credit available can stimulate consumption. Each time the economy slowed down, the authorities induced people to buy more of what they didn't need with more money they didn't have. This produced 'growth.' But it was an ersatz growth. Every dollar of borrowed money would one day have to be paid back. Every step forward would have to be followed, eventually, by another one to the rear.

In the first four U.S. recessions after the Great Depression, from the mid-'30s through the mid-'50s, the total amount of monetary stimulus was actually negative. Instead of lowering rates, the feds - witless, as usual - often increased them or left them alone. But deficit spending went up an average of 2.2% of GDP each time. Later, the feds began to get the hang of it; every recession after 1958 was met with both more credit and more spending.

As the feds put in more money and credit, they found that more money and credit was needed. At the beginning of the period an extra $2 of credit would result in $1 of extra GDP. By the time the lights went out in 2007, it took about $6 of additional credit to produce a single extra dollar of output. Each new dollar of credit had to support not only the new 'growth' the feds were after, but all the accumulated debt and mistakes from previous stimulus programs.

In the recession of 1973, Brookings Institution economist George Perry told Congress that "we should be pulling out all the stops" to fix it. The resulting fiscal and monetary stimulus program cost the U.S. 4% of GDP, according to an estimate by Jim Grant. Future generations of Fed governors and Treasury secretaries found more stops...and of course, pulled them out too. In the micro recession of 2001, for example, the combined fiscal and monetary boost amounted to 7.2% of GDP, according to Grant.

The deceptions of the Bubble Epoque, 2001-2007, were enormous. The correction has been enormous too. And here are the same economists who mismanaged the economy, offering advice to governments who mismanaged their regulatory roles, about how to keep mismanaged companies alive, so that bondholders who mismanaged their investments might not go broke. That this will result in more misery is a foregone conclusion - at least, here at The Daily Reckoning. The measure of that misery, if our iron law holds, is how adamantly governments fight to keep their mismanagement going. Just looking at the numbers, the toll will be monstrous. All over the world, interest rates have been cut and budgets padded. France's deficit is running at 8% of GDP. England is running a deficit of more than 12% of GDP. And the U.S. is mobilizing as if it had been attacked by Martians. On the credit side, the feds have cut rates more than ever before, for a monetary boost equivalent to 18% of GDP, according to Grant. As to spending, $13 trillion has been pledged...an amount equivalent to a full year's annual output of the United States of America. This response is 3 times more (adjusted to today's dollars) than the U.S. spent to fight WWII. It is 12 times more (relative to GDP) than the total committed to fight the Great Depression.

It is, we will guess, what makes a great depression even greater.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• The Solution to a Depression is a Depression
• Buffett Not Worried About Depression But How Recovery is Financed
• If the Economy is Not Recovering It Isn’t Getting Enough Stimulus
• The Country is Going into a Recession with its Finances in the Worst Shape Ever
• Capitalism Always Takes an Economy Where it Ought to Be

In February the government raised its borrowing ceiling from $75 billion to $200 billion. Last week, Finance Minister Lindsay Tanner said the bleak IMF report highlighted the big revenue gap in Australia's budget. He said Australia might have to raise its debt ceiling to $300 billion.

This is the nice thing about being a sovereign government. A household cannot arbitrarily vote itself the power to go deeper into debt. Households are at the mercy of their creditors. This either forces households to live within their means, or forces lenders to be more discrete with their loans.

A sovereign government generally doesn't face the same kind of restrictions on its ability to borrow. The only real restriction is that it doesn't much up its public finances so badly that creditors begin to demand higher interest rates. Or even worse, turn their back altogether.

Granted, Australia's funding needs look pretty modest in the global scheme of things. But the question we ponder to start the week off is whether the Rudd government can trash the country's credit rating even more quickly than anyone expected.

Australia's triple A credit rating could indeed be at risk, according to an article in the Sunday Age. S&P sovereign risk analyst Kyran Curry says his agency is watching Australia's current account deficit to determine if the government is borrowing more than it should. He says the current account deficit shows both Australia's need to import capital and the effects of declining export revenues (an even larger deficit).

He wasn't ringing any alarm bells just yet. But it was pretty clear what he meant. "We believe this Government will develop a credit exit strategy to stabilise its fiscal (budget) position in the medium term...But if the balance sheet weakened (the current account deficit), combined with a further weakening in the fiscal position (the budget deficit), that could bring some pressure on the rating."

"Pressure on the rating," means higher borrowing costs for the government in the future. That makes all sorts of financing more expensive, and exposes Australia's big vulnerability, its reliance on foreign capital to grow the domestic economy.

So how big would an annual deficit have to get before the ratings agencies downgraded sovereign Aussie debt? "It is believed a deficit of $60 billion or more could prove a trigger point for ratings agencies to re-think the outlook, which would lead to higher interest rates and a bigger taxpayer-funded public interest bill," the Age concludes.

David Uren in the Australian writes that it could come sooner than you think. "The crunch point for government borrowings will be reached in 2010-11, when government bond issues totaling $17 billion fall due, compared with just $6billion in 2009-10. This would potentially lift the financing requirement in that year to well above $70 billion, requiring the Treasury to issue bonds at a rate of more than $1.3billion a week."

The job of borrowing $1.3 billion a week from the rest of the world falls on the shoulders of Andrew Johnson, the Chief Executive Officer of the Australian Office of Financial Management (AOFM). Good luck to him on that.

Mr. Johnson gave a speech in Sydney last week called, "Australian Government Debt in a Changed Financial World." In that speech he said, "If we were to continue our current pattern of bond issuance at the rate of $1 - 1.4 billion per week, this would provide $48 -$ 67 billion over the course of 2009." He then showed a chart to prove it.

Source: www.aofm.gov.au

Let's be clear, we're not saying the AOFM is going to have trouble selling this much Aussie debt. Some of it will be bought domestically by super funds. Some will be bought by European and North American financial institutions. And some will be bought by the Chinese we reckon. One clear result is that non-residents will end owning a larger piece of Australian government bonds than ever before.

Source: www.aofm.gov.au

Maybe it's good that foreigners want a piece of Aussie debt. Maybe that means the place remains attractive to foreign capital. And maybe it means the government can run even larger deficits in the coming years without paying substantially higher interest rates. But maybe it also means the Aussie dollar is headed down soon.

Over to Alan Kohler at Business Spectator who writes that, "International investors will not buy Australian government debt at a yield of 4.7 per cent and an exchange rate of 70c/70¥, when debt levels are at the point where a negative rating watch is likely, if not an actual downgrading." Alan predicts/suggest that the Reserve Bank ease the government's borrowing pain by lowering the cash-rate to two percent by June 30th.

It's just over two weeks until Wayne Swan has to present his budget. But we'd expect currency and share markets to start putting the pieces together before then. The weaker Aussie dollar ought to be a bonus for the Aussie gold price (and investors in gold shares). Meanwhile, another big question is whether the share market can keep up its recent run.

You know our take on it by now. Deleveraging and liquidation have a long way to go. There are many more housing-related losses to take for U.S. and European banks (not to mention emerging market debt). Governments are trying to spend their way out of it, and in the process they're jacking up tax rates to soak the rich.

Bottom line? The plan to borrow and spend our way out of the recession isn't going to work. The results of the stress tests for U.S. banks are due the first week in May. But the bigger stress test is going on in the bond markets right now. It's a stress test for sovereign governments in the U.S., the U.K. and here in Australia. Who's going to pass and who's going to fail? More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Australia’s Capital Crisis and its Chinese Future
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• Government Debt Bubble is What Directly Precedes Inflation