Your editor was semi-conscious over the Pacific ocean at the time, so he can't vouch for reports. But our 30 hour trip back from Baltimore, via Chicago, L.A., and Sydney gave us time to think. Are we just being a paranoid nutcase about the global economy? Or is the position - gradually reduce your exposure to stocks and increase your tangible asset holdings - pretty sensible in a world with soaring debt and ambitious socialists?

You'll find our answer in just a moment. In the markets, it's pretty sunny out. While most of Australia idled its way through Labour Day yesterday, the ASX/200 crested through 4,800. It was a six-week high for the index. And then the news got better.

Newswires report that Royal Dutch Shell and PetroChina have offered $3.31 billion in cash and stock for coal-seam-gas player Arrow Energy (ASX:AOE). There's some consolidation going on now in Queensland's unconventional gas sector. So what should you do?

Nothing. The time to do some speculating was in November and December of 2008. That's when our colleague Kris Sayce tipped two of the entrants in the CSG race in Queensland. As the projects were "de-risked" the share prices went up. We phoned up Kris down the hall this morning and it is long-since out of his LNG positions.

The point? You have to be a year or two ahead of these big ideas and risk looking like a fool to make the big money on them. There's probably plenty of safe money to be made still. And if you are not a speculator or you don't have money you can't afford to lose, you shouldn't be playing the small cap game at all.

But as we contended at a dinner in Baltimore last week, the best reason to be in equities at all right now is for the chance to make five or ten times your money. These are Taleb's positive Black Swans, the low-probability, high-magnitude events that are actually good for your portfolio. Your much better off owning a portfolio of disruptive technologies or prospective ore bodies leveraged to higher commodity prices than blue chip stocks. Why?

The share market as a method for long-term, safe wealth-generation is a dead letter. That is, it ain't gonna happen that way anymore. Stocks are up nearly 70% from their March 9 lows of last year. The reflation rally engineered by monetary and fiscal expansion in the last year has merely papered over some huge structural weaknesses in the global economy.

But more importantly, the share market is at risk now for a big fall as it was in the middle of 2007 when the Bear Stearns story broke. Since then the perimeter of global markets has gradually been overrun by the forces of wealth destruction. Investors retreat into a smaller and smaller circle of "healthy" institutions and currencies - which only heightens their risk to further asset write downs.

The basic problem is that the global illness of too much debt has been remedied by more debt, which is no remedy at all. France and Germany may bail out Greece. But who will bail out Europe? And who will bailout the United States when public debt could rise to be 716% of US GDP in the Congressional Budget Office's alternative scenario (see page 20 for the figures).

Of course if you really think stocks are cheap now, your best bet would to be buy them and hold them. It's worked before. But we wonder, given the demographic forces in the Western world, if there is simply going to be more sellers than buyers in the coming years as the boomers liquidate.

Granted, we're arguing for a change to the prevailing conventional wisdom of the last 30 years. But hasn't the last two years given you every indication that the world really is different now and that what worked for you before in investment markets may not work again?

Or if you prefer the argument in more concrete terms, have a look at what Karl Denninger has said about the systematic balance sheet fraud going on in the United States. Dennigner shows that the suspension of market-to-market rules for U.S. banks did not - surprise surprise - lead to any improvement in asset quality.

But it's only at liquidation when the banks are taking over by the FDIC that the banks admit they've been carrying loan portfolios at much higher valuations than market prices would suggest. They only realise their losses when they are technically insolvent on their fictitious asset values. You wonder how many U.S. (or Australian) banks are doing the same thing.

Denninger reckons, based on the write-downs in assets on the firms seized by the FDIC, that total unrealised losses on bank loans could be between $1.5 and $3 trillion. Imagine what that would do to credit markets. And if the Fed tried to paper it over, imagine what that would (will) do to the dollar. Now imagine having the chance to buy gold at $1,124 an ounce.

Of course the underlying assumption to the recovery narrative has been that the bank collateral would always recover in value once the real estate market recovered. And that would happen with the passage of time, low interest rates, and short memories.

But in America at least, it's nowhere close to happening. If anything, a second and destructive down leg is coming. This is why banks continue to hold large excess reserves at the Fed. They know they're going to need it.

The underlying belief to all of this is that the credit boom has already gone bust and assets won't fall any further. You see this fiction over and over in America with the ramshackle and largely failed attempts to modify mortgages with longer terms and lower interest rates. But the basic problem - the house just isn't worth that much - is ignored.

Here we are, then, a year into the rally. The great central bank counterfeiters of the world have pumped up prices - presumably so those in the know can sell at a smaller loss, or in the case of the investment banks, at a substantial profit. But the real economy remains massively burdened by debt. For the rest of this week, we'll look at why we think the end-game to all this will play out over months, and not years. And why it won't be deflationary. Until then...

Dan Denning
for The Daily Reckoning Australia

• A Sovereign Debt Crisis Bullish for U.S. Dollar and Bearish for Gold
• Corporate Debt is Just One Aspect of the National Debt Problem
• Debt Problem Has Not Gone Away
• It All Comes Down to Debt Again for NAB
• Australia Has Highest Household Debt to Disposable Income Ratio in World

Debt, debt, debt, debt, debt! Everywhere you go, it's waiting for you.

From government, to private lives, it has become the number one facilitator of any given action. For proof, we suggest you resist the urge to channel surf during commercials. Instead, why not endure the financing options that will be spruiked at you by hyperactive dancing sales people. Or, for a less painful option, consider the effect an interest rate rise has on the disposable income of new home owners victims.

Money may make the world go around, but it's debt that dominates the world of money.

Like a giant spinning top, the global economy has relied on the increased economic flow and circulation that debt provides. Eventually it will stop spinning and fall over on its side.

You see, it works like this: Central banks are like the tip of the spinning top - the point upon which our debt based economic system expands from and pivots off. It's a very narrow tip.

The Financial Crisis is an indicator that the world economy has become extremely top heavy with debt and is dangerously wobbling around like a slowing spinning top.

Governments and central banks have managed to engineer some more spin, but only at the expense of piling more debt on top of the already wobbling structure. This only increases the stakes of keeping it spinning.

But have we discovered the point where more debt will not provide more growth - only more instability? Who knows? (Other than these two academics, who reckon they've figured it out.)

The key point is that a roaring economy might be great, as the boom period showed us. But if this boom is at the expense of stability, and only artificial spin is keeping it going, then we are going to pay for it eventually.

National Debt

''Prepare for a very difficult economic time, which you will not be able to escape,'' said the chairman of the Netherlands Authority for Financial Markets at the ASIC summer school.

The Sydney Morning Herald (SMH) explains why Hans Hoogervorst is so 'optimistic':

"Australia is unlikely to avoid an imminent economic downturn caused by excessive government debt".

Hans' timing is excellent. But why stick to government debt?

Dan Denning reports that "...in another ABS release we learn that the country's net debt figure has reached a new all time high, both in nominal terms and as a percentage of GDP. The net debt (public, private, household) is $647 billion. It was up $14.2 billion in the December quarter and is over 60% of GDP."

International debt flows are particularly big on the economic agenda for Australia. Michael Stutchbury, in Tuesday's Australian Newspaper, explains that the traditional measure of trade flows serves another purpose for Australia:

"Today's economic orthodoxy suggests current account deficit simply measures the extent to which domestic savings are not big enough to finance the mining investment boom."

Going back to Dan's commentary:

"The net foreign debt and current account deficit are a reminder that much of Australia's current prosperity - from house prices to mining profits - comes via borrowed money. Of the $647 billion in net foreign debt, $426 billion - or 65% - is owed by Australia's financial corporations."

With debt running so deeply in the veins of the Australian economy, would it even be possible to have a healthy type of growth emerge? Or would a pickup in economic activity simply be another re-leveraging, doomed to topple the economy at some point in the future?

Austrian economic theory, to which the Daily Reckoning subscribes, would suggest that a period of "creative destruction" must clear out all the malinvestment and excessive leverage before healthy growth can resume. Some of this has occurred, but nowhere near enough, especially in Australia.

Mortgage Debt

Tim Colebatch at the SMH reports that Australia's mortgage debt has "soared" to more than $1 trillion. That's 15 times what it was 20 years ago. The breakdown of the figures since 1990 is fascinating. A 12 fold increase in mortgage debt for people's own homes, as well as a 30 fold increase in mortgage debt for rental investors, while disposable income merely trebled.

"In January 1990, home mortgages ate up just 28 percent of our disposable income. By January 2000, that had ballooned to 66 per cent, and by January this year, it doubled again to 134 per cent.

"Households' willingness to take on greater debt powered much of Australia's economic growth from 1990-2010, but with our households now as indebted as any in the Western world, economists say that will not be repeated."

All this not only inhibits growth, but exacerbates just how sensitive the Australian economy is to interest rates.

Housing

Apparently, a quarter of Sydney homeowners have already experienced the other side to Australia's housing boom. Nick Gardner at The Daily Telegraph writes:

"Despite a broadly rising market, property analyst Residex has revealed 24 per cent of properties bought and sold between January 2005 and January 2010 fetched less than the vendors had paid.

"The average shortfall was more than $54,000 but varied between suburbs.

"The biggest losses were in the affluent Neutral Bay/Spit area, where typical shortfalls topped $275,000.

"But even in Campbelltown, where the median house price is a modest $346,500, 36 per cent of properties sold for less than was paid, with an average shortfall of $31,000."

No matter how wealthy your suburb, you aren't safe from Mr Market.

The real problem faced by people who have lost value in their homes is that the price of the home they are moving to is likely to have risen. Their loss has two sides to it; the nominal loss on their house and the increased price of the new house.

Assuming this is true, it would point out something which has confounded any neutral observer to property markets since the Stone Age. If house prices across the board rise by say 50%, this would be heralded as a success in the property industry. If you realise this gain by selling and moving out, you still have to live somewhere. Your new place would also have increased in price, forcing you to pay more. So, in terms of standards of living, you have got absolutely nowhere.

Any gain is offset by an increase in the price of the house you move to.

Obviously, house prices don't move identically across the board. This means there are opportunities to gain. But spruiking an increase in a nationwide price index doesn't equate to Aussies being better off. It equates to those Aussies who didn't own a home, but want to buy one, being worse off. That means it's even worse than a zero sum game.

So, the property spruikers will claim that it's all about picking the right locations. Well, if house prices in Melbourne rise by 50%, while house prices in the rest of Australia stay the same, would Melbournites be better off?

No, unless they wanted to move away from Melbourne...

Sovereign Debt

The 'Ouzo crisis' has entered a critical phase. The Greek people are having to make crippling blows to their public and personal budgets. Worst of all, Elly Koufakis, who "...used to buy special SpongeBob SquarePants toilet paper for her children, [says] she doesn't anymore."

Other devastating accounts include that of Haris Georgatou: "After years of spending $15 a day on coffee, he now makes his own at work."

My own countrymen, ze Germans, have heard their Chancellor rule out a Greek bailout. She stated it in very Deutsche terms:

"There is absolutely no question of it. We have a (European) treaty under which there is no possibility of paying to bail out states in difficulty. Right now we can help Greece by stating clearly that it has to fulfil its duties."

Germany's history isn't great when it comes to treaties.

It would seem that the statements are just a game of terminology anyway. A German bank (rumours are amassing around KfW Bankengruppe) may be backed by the German government in a Greek bailout.

Die Welt put it unambiguously:

"The pressure is growing -- the chancellor knows that. She is still waiting for the right time to justify the billions (in aid) for Greece... But by then the situation in the financial markets could have spun out of control... The billion euro question is now therefore 'when will Merkel move?'"

Apparently investment banking giant JP Morgan considers California (the Vino crisis?) to be a bigger worry than Greece.

Dan Weil explains this is because of the possibility of contagion. Also, JP Morgan hedges its European exposure, so others bear the risk. Those two points appear largely contradictory, but oh well.

Economic Outlook - Look Out

Some nice examples of how government intervention works come from Sean Hyman at Moneynews, with his article titled "Don't Believe What You Hear: It's Not Getting Better".

"Now Fannie Mae says ... that it needs another $15 billion, bringing its total to more than $75 billion. This company is such "crap" that it's had 10 consecutive quarterly losses. Its latest quarterly loss was $16.3 billion.

"AIG lost $8.87 billion in the fourth quarter.

"The FDIC has shut down more banks in Nevada and Washington. That makes 22 bank failures this year (and 140 banks last year and 25 the previous year)."

Then Reuters chimes in with this:

"Some 400,000 jobless Americans could exhaust their unemployment benefits over the next two weeks, the Labor Department said. By the end of March, 500,000 workers could lose the COBRA subsidies that help them pay for health insurance."

And the Washington Times reports the statistic that sums it all up:

"Moreover, for the first time since the Great Depression, Americans took more aid from the government than they paid in taxes."

That is worth reading twice.

If you are wondering what the Reserve Bank of Australia (RBA) is thinking as it continues its rate rises, check out their October 2009 minutes. It seems the RBA is reading up on Austrian economic theory. The ABC even considered it worth quoting this part of the minutes directly:

"Very expansionary policy could result in the build-up of other imbalances in the economy, which would ultimately be detrimental to economic growth."

This revelation should make RAB governor Glenn Stevens very nervous when he looks to his comrades' rates overseas. The nearest rate of a developed nation is 0.5%. That's 1/8th Australia's and "very expansionary".

Retirement advice for Terrorists

The London based Daily Mail reports that the cancer stricken Lockerbie bomber is alive and well, having so far lived twice as long as predicted when he was released from a Scottish prison on compassionate grounds.

Yes, terrorist and compassionate grounds.

Anyway, upon hearing of the luxury and heroic status being enjoyed by the bomber, American blood began to boil. James Taranto of the Wall Street Journal spun the whole thing like a magician to apply to the socialised healthcare debate, which seems to be reaching our own shores:

Great Moments in Socialised Medicine

"In Britain, the government itself runs the hospitals and employs the doctors," claims former Enron adviser Paul Krugman. "We've all heard scare stories about how that works in practice; these stories are false."

"This defence becomes harder to believe when a cancer patient can get better care by going to Libya."

To be fair, James Taranto's comments on a daily compilation of amusing articles are not entirely serious.

Global Warming Casualties

There have been further casualties on the global warming front, with a baby girl surviving a gunshot wound in her family's suicide. The wounded survivor lay among her dead family members for three days. Why did they have to die? The suicide note explained it was their fear of global warming.

Dr Mark Perry of the University of Michigan posted the following on his blog:

"From Al Gore's article We Can't Wish Away Climate Change in today's NY Times:

"It would be an enormous relief if the recent attacks on the science of global warming actually indicated that we do not face an unimaginable calamity."

Dr Perry has degrees from George Mason University, the only university in the world which offers a specialisation in Austrian economics (as far as I know).

Lastly, my apologies for providing a reference to an outdated article on Eastern Europe and thanks to the readers who pointed this out. I was intending to feature Eastern Europe in its own section and did not revise the content that I decided to keep. Considering Eastern Europe still exists, it seems the article's forecast did not eventuate - yet.

Have a great weekend.

Nickolai Hubble.
The Daily Reckoning Week in Review

• Global Illness of Too Much Debt has Been Remedied by More Debt
• CBA and Their Bad Debt Problem
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• China Stepping Up Purchases of U.S. Treasury Debt
• Apparently More Debt is Now Acceptable in Australia

But the financial industry blew itself up in 2007-2009. Now, what do we have?

The government! Doing all the same things...making the same mistakes (only worse)...and working hard to blow itself up.

"Basically, it's over..." says Charlie Munger. Warren Buffett's partner figures the glory days of the US economy/empire are behind it. He spelled this out in what he calls "a parable," in Slate Magazine.

This puts Munger in direct opposition to all those economists, bankers, politicians, pundits and meddlers who think they can do better than the financial industry. Martin Wolf, in The Financial Times, says the challenge is to "walk the tightrope" between too much additional stimulus and cutting off stimulus too soon.

Richard Koo and Paul Krugman think the feds need to give the economy a lot more stimulus in order to offset the forces of contraction.

Most people think the economy will muddle through somehow...thanks to all those geniuses working at the Department of the Treasury and the Fed.

Dream on! The economy might muddle through or it might not. (The Wall Street Journal says growth rates have already returned to normal.) But if the economy does pull out of this depression...it will be in spite of all those ham-handed central planners who are telling it what to do, not because of them.

Yesterday, the Dow fell 100 points. Gold dropped $9.

As far as we can tell, we're still in a depression - that is, a deflationary contraction. You'll see a lot of contradictory statistics and BS analyses for the next 5 to 10 years. What you won't see is real growth...not until debt is substantially written off, costs are reduced and a new economic model is discovered. The 'growth' we're seeing now is largely an illusion, a mirage, and an attractive nuisance. We'll have to pay for it later!

To put it another way, you won't see real growth until there's something solid to build on - a new foundation of lower costs and fewer leeches.

Yes, dear reader, the problem is not a liquidity problem. It's not a banking problem. It's not even just a debt problem. The bigger problem is that the US economy - but nearly the same could be said of Japan...the UK...Italy...and other places - is too expensive, too rigid and too full of zombies.

Munger is right. At least, he's right about what has gone on so far. The financial industry turned the country into a casino...and too many people lost their money.

We don't know what happened in the second part of Munger's parable. We couldn't get the 2nd page of the Slate article on our laptop screen. But he's a smart guy. We doubt he missed the government's role. First, the private sector loaded itself up with debt. Now, it's the feds' turn.

Was it Ronald Reagan who said of the Soviet Union, that it was on the "wrong side of history?" The derelict Bolsheviks were definitely on the wrong side of history in 1989. We knew it. They knew it. It was such a glaring problem; they had no choice. Their economy was imploding - thanks to rigid central planning. They gave up and switched sides.

But now it's the US that is on the wrong side of history. Like the Soviet Union, it tries to impose its will, by force, on Afghanistan. Like the Soviet Union, it has too many expenses and not enough income. And like the Soviet Union, it tries to impose its will on the domestic economy too - by central planning. Not exactly in the heavy-handed fashion of the old apparatchiks... This is post-Berlin Wall central planning. Collectivism with a clown face.

The US nationalizes key industry and borrows heavily...shifting the weight of economic 'growth' from the private sector to the government. Everything from home finance, banking, insurance, automobiles, employment and food is now owned, provided or subsidized by the US government.

After the Soviet Union fell...the rest of the world went over to look down the collectivist hole...and then slid in too. In October 2009, the IMF counted 153 separate stimulus or bailout programs. If you bought a house or a car in 2009, you may very well have had the government to help you. And now, if you hire a new employee, you will have the government by your side again. If you get sick, you will have the comfort of knowing that the feds are in practically every examining room, every operating room, every drug laboratory, and every pharmacy. And if Obama has his way - there will be even more of them. Is there any economic act, howsoever trivial, that no longer involves government support, approval, or funding?

Munger may have pointed out. Or maybe he didn't. In either case, we will: the US economy was at its strongest before it was burdened by so many people depending on it...and so many smart people helping it along.

It won't make much progress again until it gets rid of those people. And that won't happen until it has crashed...and become desperate. Living at the expense of others is a hard habit to break.

Bill Bonner
for The Daily Reckoning Australia

• Chinese Economy Seems to be Growing
• Major Premise That Government Economists Can Improve Workings of a Free Economy
• Price of Oil May Rise Due to Scale of Georgian Conflict
• US Economy is Some 11 Million Jobs Short of Full Employment
• The Bubble Deniers Deny that Their Own Stimulus Caused it

Mr. Papaconstantinou was speaking of Greece. But he described much of Europe, Britain, Japan and the US. And, in his fortunate metaphor, he prophesied. The big ships can't be turned around. They're going to sink.

Greece has been taking on water for many years. But this was the first time a finance minister of any country signaled to lenders that they should head for the lifeboats. Then, looking around, the press noticed that one of the lifeboats had already been launched. In it were no crying widows and no shivering orphans. Just one very satisfied Lloyd Blankfein, chief executive of Goldman Sachs. He had sold the Greeks their debt, said the papers; now he has sold it short.

Der Spiegel was first to break the story. Then, it came out in The New York Times. And then Bloomberg was on Goldman's case. It wasn't the mess that the Greeks had gotten themselves into that attracted the press attention, it was who had helped them get into it. Greece has been in default to its creditors in one out of two years since it got independence in the early 19th century. It is almost the definition of a poor credit risk. By what crook and what hook did the slippery Hellenes manage to get themselves into the Euro Club?

Creativity in art makes for masterpieces. Innovation in industry may lead to success. But when the financial industry schemes and canoodles, it invariably leads to disaster. Goldman Sachs, the most cunning of Wall Street's financiers, is fundamentally a debt monger. Like a liquor store or a drug dealer, it earns money to the extent it is able to move its merchandise. The more the customer wants, the more Goldman earns. Whether the purchase is good for the customer or not is not Goldman's concern. But just look at where the moneylenders have been most creative and you will surely find something you should not own.

In the present example, Goldman earned a total of $300 million. Immediately, the pundits kvetched that its work was both criminal and noxious. As to the noxious charge, Goldman needs no defense. Greece has always been a notorious drunk. Goldman is merely a bartender. The money monger seeks neither the ruin of his customer, nor his reformation.

As to the criminal charge, Goldman says it was perfectly legal to structure the deal with Greece the way it did. Moreover, the authorities in Brussels have been aware of it for years...and even seemed to approve of it. Member states were allowed to "use derivatives to adjust deficit ratios," The Financial Times revealed last Wednesday. Goldman arranged for Athens to swap cash for a stream of income coming from an airport and a lottery. Was it debt or equity? Had Goldman lent Greece money...or had it bought part of the national patrimony? It really makes no difference; whatever you call it, the Greeks had impaired their balance sheet. Goldman had merely made a buck helping them do it.

Goldman need not worry about persecution; it has friends in high places. Such as Mario Draghi. Mr. Draghi has a long and impressive résumé. Not only has he been a managing director of Goldman Sachs, in charge of business development in Europe, he's also served as director general of the Italian Treasury and lately, Italy's central bank governor. And now he's up for the post of head of the ECB, to replace Jean-Claude Trichet, who is scheduled to step down next year. He is Goldman incarnate - banker, servant of the people, one of the financial world's high priests from whose hands come unction, salvation...and cash.

In the US, Goldman is so tight with the feds it is known as "Government Sachs." But what's new? Governments always turn to rich, well-connected moneymen for finance. The Rothschilds largely financed Britain's continental allies in its war against Napoleon in the early 19th century. Then, in the early 20th century, JP Morgan financed the British in WWI. In both cases, the lenders found innovative and often complex ways to keep the money flowing. Now, we are in the early 21st century and Goldman is providing the money.

But this time it is different. Borrowers are not at war. Instead, they borrow to blow themselves up. There is no foreseeable end to their borrowing. The Greek affair is peanuts. America's ink is so red it looks as though it has cut an artery; this year's deficit alone is $1.6 trillion. Japan, the world's second largest economy, now borrows more than it raises in tax revenues. And while the Greeks run a deficit of 13% of GDP, in the UK the deficit is even higher at 14%.

Goldman is right; this is a good time to sell government debt. Better to get into the lifeboats too early than too late.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Meredith Whitney and the Buy Recommendation on Goldman Sachs
• Warren Buffett is Buying Four Percent of Goldman Sachs
• Rising in Defense of Goldman Sachs
• Fed Made More Money than Goldman Sachs
• Traders Sell Bank Stocks Due to Goldman Sachs Surprise

It is our contention that similar to Mr. Madoff's hedge fund, the sovereign debt markets in the West have now become gigantic scams. Only this time around, the players have changed and the sums involved are significantly larger.

Figure 1 highlights the incredible expansion in America's national debt. It is noteworthy that at the turn of the millennium, America's national debt was less than half of its current value. Put simply, American policymakers have taken on more debt over the past decade than they have over the last one hundred years!

What is more astonishing is the fact that America is funding a large portion of its newly issued debt by direct purchases from the Federal Reserve. In other words, as private-sector demand for US Treasuries wanes, Mr. Bernanke is creating new money so that Mr. Obama's government can bail out insolvent financial institutions. Strangely, the American establishment is quite content to pledge the economic fate of its future generations in order to protect the bondholders of dubious 'too big to fail' corporations. Hmm, talk about change...

Apart from the world's largest economy, various other nations in the 'developed' world are also following such misguided policies. For instance, UK's national debt is exploding and is forecast to reach GBP1.1 trillion by 2011. At present, its national debt is worth GBP891 billion and this equates to GBP14,304 for every man, woman and child in the United Kingdom!

Elsewhere in Europe, the situation is equally dire in nations such as Ireland, Spain, Greece and Italy. Furthermore, various countries in Eastern Europe are on the verge of economic doom.

Given the precarious state of so many economies in the West, we are amazed that the respective government bond markets have not fallen apart at the seams. Perhaps, they are all heading down Japan's route, where national debt is now above 170% of GDP, yet the yield on Japanese government debt is pathetic. But then again, perhaps they are not...

In our view, in the not too distant future, the interest payments on the outstanding national debts in the overstretched 'developed' nations will become so large that their central banks will need to create money just to keep the Ponzi schemes going. When that happens, the game will be up and we will probably experience a total breakdown of the fiat-money experiment. At this stage, we do not know when the day of reckoning will arrive but we do know that all Ponzi schemes ultimately collapse under their own weight and this one will be no different.

Given the shocking debt overhang in the West and the threat of surging inflation later this decade, we cannot understand why anybody would want to lend money to bankrupt governments!? In the worst case scenario, these naïve bondholders risk losing their entire capital and the best outcome involves a significant loss of purchasing power due to inflation. Accordingly, we are not investing in sovereign debt and we suggest that you refrain from lending money to dubious governments.

Finally, although we are pessimistic about the long-term prospects of government debt, we are aware of the possibility of a near-term rally; especially if there is another round of risk aversion in the financial markets. So, if we do get another deflationary scare and bond prices rally, holders of government debt are best advised to liquidate their positions.

Furthermore, if our world-view is correct, extremely high inflation is now inevitable. As long as the monetary velocity in the US is weak, inflationary expectations will remain subdued, but once the economic activity picks up, the world will experience spiraling inflation. When that occurs, hard assets will protect the purchasing power of your savings. Accordingly, we have allocated a large portion of our clients' capital to energy (upstream companies, oil services plays and alternative energy plays), precious metals miners and diversified base metals miners.

At the time of writing, precious metals are at a critical juncture and the price of gold is trading above an important support level.

Figure 2 shows that the price of gold peaked at US$1,075 in October 2009 and that level is now acting as important support. Now, if the bull-market's trend consistency is intact, then the price of gold must rally immediately and challenge its December high. At the very least, the price of gold must hold above US$1,075 per ounce. So, will gold manage to stay above this critical support level?

Before we attempt to answer this question, we must confess that short-term forecasting is extremely difficult and we really do not know what will happen over the following days. However, what we do know is that the macro-economic environment has never been better for the yellow metal. After all, mined supply is in decline, investment demand is rising, the public sector has become a net buyer of gold and hatred towards paper currencies is on the rise. Under these circumstances, we expect gold to perform very well. However, you must remember that the American currency is in rally mode and this is exerting downward pressure on all metals.

Now, if we were forced to take a stand at gunpoint, we would say that the odds of a rally in gold are 65/35. Accordingly, we are holding on to our positions in precious metals mining stocks and may consider lightening up during spring (which is when precious metals usually make an intermediate-term peak).

Now, if gold does the unexpected and breaks below US$1,075 per ounce, then we envisage a deeper correction to the US$1,000 per ounce level. Even if that happens, we will continue to hold on to our positions in gold mining companies, which have already depreciated in the ongoing stock-market correction.

Short-term setbacks notwithstanding, we continue to believe that hard assets are in a secular bull-market, which will probably end in a gigantic mania. According to our guesstimate, the bull-market will end in the latter half of this decade; at a time, when inflationary expectations are spiraling out of control.

Make no mistake, the policy actions of the past 18 months are extremely inflationary and once the American economy stabilises, we will experience a significant increase in the general price level. And before this is all over, government bonds will (once again) be recognised as 'certificates of confiscation'.

Regards,

Puru Saxena
for The Daily Reckoning Australia

• The United States: The Largest Ponzi Scheme in the World
• Gold and Silver!
• Federal Reserve Wants to Debase the U.S. Dollar
• Inflation is Our Future
• Exhausted Gold Shares

Hold your horses, dear reader. We'll have to wait to find out.

The papers attributed the big upward thrust in share prices to news from Europe. The specific fact that caused the swing to profit had to do with Jean-Claude Trichet's travel plans. He was in Australia for one meeting; now he's coming back to Europe early so he can partake of another.

What has caused him to call his travel agent is a problem centered in Greece. The Greeks are in a jam. They spent too much money in the bubble years. Then, they saw their tax revenues disappear in the bust.

Sound familiar? It should, because the same could be said of most of the US states...and most of the world's countries, emerging markets excepted. They all spend too much. Almost all run deficits. And almost all their deficits are getting bigger and bigger.

So far, the big economies don't have a problem. Lenders think they are good for the money. Almost miraculously...or supernaturally...the USA - the world's biggest borrower - is able to obtain financing for 10 years at less than 4% interest. Since the official inflation rate is 2.7%, that means lenders give up their money for a real rate of return of just a little over 1%.

It's the little economies that have trouble. They don't have printing presses of their own. Like California or New York, ultimately, they have to balance their budgets. They can't inflate their way out of trouble. So, when their backs are to the wall they either get tough and cut expenses rudely. Or they go broke...default...and then have the cuts forced upon them.

The focus of this week's discussion is the PIIGS - Portugal, Ireland, Italy, Greece and Spain. Together they've got about $2 trillion worth of debt. And lenders are making it more expensive for them to borrow more. If this continues, they'll default. And then, say the financial authorities, terrible calamities will happen. The whole European financial system could come falling down. It would be the end of the world as we have known it.

Does this sound familiar too? It should. It's the same scare tactic used after Lehman was allowed to go under. AIG had to be saved. And Fannie and Freddie. And GM.

Now, that lame argument is probably going to lead to the bailout of Greece...and by extension, all the other insolvent nations along the periphery of Europe. The debts will be collectivized...just like those of Fannie and Freddie. Instead of being allowed to fail on their own merits, in other words, European nations are locking arms...they are all going to fail together!

Germany's politicians are already talking about a program of support in a "broad sense" for Greece and other problem economies. Soon, in Europe, the English word 'bailout' will be as common as "hamburger" or "coke."

Bill Bonner
for The Daily Reckoning Australia

• Fannie and Freddie are Finito
• The Great Correction: Awaiting Bailouts that Will Never Come
• Fannie and Freddie in a Free Market Economy
• Fannie and Freddie Say Goodbye to Veto
• USA Has Fives Times As Much Sovereign Debt As All the PIIGS Put Together

Obama to California: Uh...

Yesterday, stocks lost 103 points on the Dow. This looked like a confirmation to us. The stock market appears to have begun its next and final phase...

AP seemed to think so too:

"Stock investors see threats from all directions," said the headline.

We didn't bother to read the article. We already know the directions.

From the north, investors worry about falling consumer demand. Consumers are in a funk - they have more debt, less income, fewer jobs, and less access to credit. The only news on that front we have today is that even jumbo housing loans are going bad...delinquencies are up to 9.6%.

From the east, investors worry about the continued invasion of cheap consumer goods and cheap services. China's economy is said to be growing at double-digit rates. How can US firms compete? And what if China is a bubble, as Jim Chanos believes? When it blows up, US stocks will come down too.

From the south comes the threat of higher interest rates. The poor dopes think the recovery might be for real. If so, inflation will rise and the feds will increase interest rates...possibly cutting off the new boom.

And from the west what do they have to fear? Well, there's that business in Europe. You know, Greece and all. The PIIGS - Portugal, Italy, Ireland, Greece and Spain... Europe's peripheral countries are in trouble. Lenders fret that they might be forced to default on their debt. So, they want higher interest rates. This, of course, just makes state finances worse...pushing the PIIGS closer to default.

The PIIGS owe $2 trillion, which might need to be restructured. Yes, dear reader, the sovereign debt problem is a big one - much bigger than Bear Stearns, Lehman Bros. and AIG. But the biggest porker of all - the USA - has fives times as much sovereign debt as all the PIIGS put together.

It won't take investors long to figure out that there isn't a whole lot of difference between Greece's finances and those of the US. Each has about the same amount of debt and the same size deficit, relative to GDP. The big difference is that the US ultimately controls the currency in which its debt is calibrated. Greece does not. Neither does California.

Both California and Greece borrow long-term at about the same rate...around 6%. Lenders know that when their backs are to the wall, both governments will have only two choices, not three. They can cut spending. Or, they can default. What they can't do is wiggle out of their obligations by inflating their currencies.

Jean Claude Trichet has already made that clear:

"...belonging to the euro area, you...have an easy means of financing your current account deficit. You share a currency that is credible, so that you have a quality of financing that corresponds to that of a credible currency."

He went on to say that Greece contributes only about 3% to the total output of the euro-zone. If push comes to shove, Greece will be pushed out rather than allowed to weaken the euro.

Then, Mr. Trichet made an odious comparison. California is a much bigger part of the US economy than Greece is of the euro economy. In fact, it is more than four times as large. Will the US come to California's aid? Mr. Trichet didn't say.

It is possible, of course, that Mr. Obama will say to the Golden State what Gerald Ford said to the Big Apple. In 1975, New York City's back was to the wall. It appealed to Washington for help. "Ford to City: Drop Dead," was the famous headline in the New York Daily News, reporting the president's response.

New Yorkers were incensed. Later, they realized that by vowing to veto a bailout President Ford had done them a great favor; he forced New York to clean up its act. The city went on to its greatest years. Likewise, the feds would be doing all of us a favor by letting failure fail with dignity.

Will Obama help California mend its ways? Or will he turn it into a zombie state?

Bill Bonner
for The Daily Reckoning Australia

• It’s the Little Economies that Have Trouble
• The Debt Collection Business Booms
• Trichet Should Tell Greeks to Drop Dead
• Reality Sovereign Debt Finance Theatre
• Australian Dollar Set to Grow for the Remainder of 2008

The futures were down overnight by 72 points. Like it or not, the Aussie share market still takes its marching orders from the U.S. action. It hasn't decoupled yet - even though what drives the respective economies of Australia and America is somewhat different. Australia has resource demand for its raw materials from emerging markets. America does not. But both countries have debt (especially household debt), and plenty of it.

Here in Australia, what will investors think of the new powers being sought by the Federal government on behalf the corporate regulator, ASIC? ASIC would have the power to tap phone lines, impose fines of $500,000 on insider traders, and double jail terms for insider traders from five to ten years. Hmmn.

Better yet, what will corporate insiders think? We've seen some strange share price activity since moving to Australia four years ago. Shares move on no news and volume spikes. Then a few days or weeks later some important announcement comes out. And frankly, the disclosure rules for insider buying (or selling), or at least the enforcement of those rules, seem fairly voluntary.

Not that it's any better in America or anywhere else. But perhaps because of the smaller financial community and the under powered regulator, the insiders have a better time of it here than they might other places. Ahem.

But the power to tap telephones? Yikes. That sounds draconian. But it's fully in line with the encroachment of government power into private life, so it's no big surprise.

Outside Australia, more trouble is piling up for the world's most debt-addled nations. "We no longer classify the United Kingdom (AAA/Negative/A-1+) among the most stable and low-risk banking systems globally," said ratings agency Standard and Poor's. The FTSE finished lower on that cheery note.

This is the big back story to today's financial markets. The debt problem has not gone away. Banks have recapitalised, making up for some of their losses from 2008 and 2009. But you still have a financial system addicted to debt and leverage. Investors have bought into the recovery story, though, and taken a punt on shares at just the time they ought to be reducing their allocation to shares (in our estimate). Why?

The deleveraging that kicked off in 2008 still had a long way to run. The banks know this, which is why they've decreased risk by being stingier with lending. Shareholders, on the other hand, have done the opposite. And that could cost them.

"Any discussion about the response to the crisis," reports Peter Larsen at Reuters "must acknowledge the need to reduce the levels of debt that have been built up. A study by McKinsey, the consultancy, found that previous deleveraging episodes have generally taken four forms: a period of belt-tightening, in which credit growth lags behind economic growth for many years; massive defaults; high inflation; or a period of rapid GDP growth as a result of a war effort or an oil boom."

So which will it be? The RBA releases its report today on financial aggregates. We'll see if credit growth is lagging the economy. Not likely, we reckon. Massive defaults? High inflation (higher than the RBA is comfortable with)? Or war and an oil boom?

None of them are particularly attractive. But none have really happened yet either. That's why we think 2010 will have more fireworks. Perhaps a debt default by a sovereign government or two. And then you have fewer and fewer surviving financial firms all deemed too-big-to-fail by the government. Not good.

This just in...the U.S. Senate has voted to raise America's statutory debt ceiling to $14.3 trillion. This will allow the Treasury to borrow more money to both service existing debt and pay for this year's $1.3 trillion annual deficit. Ben Bernanke was also confirmed for another for another four-year term as destroyer in chief of the U.S. dollar by a 70-30 vote.

Prediction: at some point the American people are going to turn on the clowns ruining their money and their financial future, piling up debt that will take decades to pay off, if it's ever paid off at all. The Congressional Budget Office reckons that interest on that debt will more than double as a percentage of GDP. It nominal terms, it will triple from $202 billion to $723 billion.

That's just interest. That is the price of living above your means as a nation. That is the price (really just part of the price) for making promises you can't keep. It's a big price. And in the meantime, we'd take U.S. dollar rallies with a lick of salt. And though we read this morning that George Soros thinks everything is in a bubble - including gold - we'd keep an eye on old yeller and look to buy more on dollar strength.

Finally, we got a fair bit of mail in response to Murray Dawes' short-selling primer. We can't reprint all the questions. But we asked Murray to have a look and answer the most common ones. That he did.

He writes, that "One question that came up a few times in response to the shorting article was how long a short could last for. The simple answer to this question is that it is indefinite. There is no time limit on how long you can be short for, but in saying that you have to be aware that the lender can call back their stock at any time."

"In practice this rarely happens, but the lender may want their stock back so that they can vote with their shares at a meeting of the shareholders. In such a case the investor who was short the stock would be required to buy their stock back and return it to the lender. This could really throw a spanner into the trading plan of an investor who is short and is one of those unforseen risks that we are exposed to in trading the markets.

"Another issue that is constantly in the press is whether or not trading short is ethical. I think it is ridiculous that people turn to scapegoats and start pointing fingers whenever things don't go their way. I didn't hear anyone screaming for the heads of people who short while the market was in a huge bull market for years.

"But the situation was exactly as it is now in regards to shorting. People took on risk to go short a stock and in fact take on more risk than someone who is long because markets do rise over time. When the shorts were getting killed, people were happy for them to be short. Now that they are making money everyone is crying in their beer."

"It would be lovely if markets only ever went up, but as we learnt during the tulip frenzy hundreds of years ago, a bubble will always pop in the end. It's not the fault of the 'evil' people who dared to realise that the market was overvalued. If there is any finger pointing to be done it should be at the people who allowed the bubble to form in the first place. And we all know who that was (see also Greenspan and Bernanke)."

For the record, Murray has a few short trades open in Slipstream Trader. A few weeks ago, in a forecast to Slipstream readers, he called for a decline to 4,600 on the ASX/200. The index trades at 4,619 as we write. Stay tuned next week for a fuller introduction to what Murray's been up to. We admit we've kept his trading method under wraps. We'll explain why next week. Until then.

Dan Denning
for The Daily Reckoning Australia

• The Problem With a Well-Diversified Portfolio
• CBA and Their Bad Debt Problem
• Trading Airline Stocks in an Energy Bull Market
• What is Short Selling?
• Global Illness of Too Much Debt has Been Remedied by More Debt

According to theory, the markets know more than any single investor, analyst or economist. In theory, the markets know everything there is to know. In theory, the markets are always right.

But what the heck? This is the same stock market that signaled clear sailing ahead ten years ago. Soon after, equities hit an iceberg. They sank for the next decade.

Here at The Daily Reckoning, we had our own views. At the beginning of the '00s, we told readers to sell their stocks. We were right. The stock market was wrong. Heh heh.

So, who ya gonna trust now? The stock market... Or, The Daily Reckoning?

Who knows... Maybe we're wrong this time, but we see another 10 years of trouble coming. Two years ago, the credit cycle peaked out. After half a century of adding debt, the private sector had had enough. Borrowing turned down. Last November, it registered its 10th month in a row of declines, something that had never happened since they began keeping records after WWII.

Consumer spending has held up surprisingly well. But with credit contracting and unemployment high and rising, it can't continue.

Small businesses create jobs. But who wants to take the risk of funding a small business now? Not the banks. And the capital markets are closed off to small businesses. You have to have a big business - preferably one that is dying... Then, you can get all the money you want from Wall Street and the feds.

Since the downturn began two years ago, 7.5 million jobs have been lost. There is no sign that they will be found anytime soon. Jobless people do not spend a lot of money. Ergo, you can't really expect an economic surge until people get jobs.

When will that happen? Possibly years from now...maybe 2...maybe 5...maybe 10...

Yes, dear reader, we are in a depression. It is a period of adjustment...of correction...of de-leveraging...of paying down debt. And there's not much the feds can do about it - except disguise it...delay it...and make it worse.

The government can spend money. The government can inflate the currency. But it's neither government spending nor inflation of the currency that makes an economy healthy. If inflating the currency could make an economy prosper, where did Zimbabwe go wrong? And if government spending could boost an economy, what did Cuba do wrong? Or Venezuela? The two-bit, banana republic economies are almost all burdened by too much government stimulus. The feds tax too much, spend too much, borrow too much and inflate too much. Instead of doing their jobs - enforcing property rights, protecting people from crime, and staying out of the way - they meddle and spend. The president gets a fancy house and lots of security guards. And the economy rots.

Of course, we could be wrong about what is happening in the US. But our guess is that the stock market is wrong instead. Stock market investors anticipate a return to 'normal.' But the normal they're looking at is a very unusual credit bubble that blew up and can't be mended. The real normal is what we're getting. And the real normal is a world where bad stuff happens. Investors make mistakes. Markets make mistakes. Often, they are misled by their own financial authorities, such as Ben Bernanke. The US Fed chief meddles in the economy and distorts the picture. Investors look, but get the wrong idea.

Our guess is that stock market investors are seeing the distorted picture caused by the feds' meddling...not the real picture. They look. They see low interest rates. They see stimulus. They see a stock market that seemed so friendly and so rewarding for so long that they can't imagine anything else. They see a government taking action...and making things better. They read Thomas Friedman and think the 'political class' can fix whatever problems it encounters.

But in the real world, the political class is a life-threatening parasite. Allow it to grow large enough and the host - the private economy - will shrivel up and die.

And in the real normal world, markets go up...and then they go down. We are in one of those periods of decline. We are in a depression, with a growing, parasitic political class. This phase won't end any time soon.

Gary Shilling is probably right. He says to buy Treasury bonds and the dollar. They're both probably going up this year.

Why? Because we are in a depression. And when investors finally realize it they will seek safety. They will buy US Treasury bonds, raising prices and lowering yields. Those Treasury bonds are in dollars, by the way. Investors will want dollars.

There are two main emotions that drive investors - fear and greed. Lately, greed drives them to buy emerging markets, stocks generally, and commodities. Fear drives them to dump all their risky investments and head for cover. They believe cover is found in the dollar and in US Treasury bonds - traditionally, the world's safest credits.

"Ireland has changed so much," said a colleague at last night's dinner. He was speaking early in the evening. Later, we went to Henry Downs' place...where the #9 whisky is as smooth as a baby's derriere. We can't remember what happened after that.

"The Irish had big families. Everyone had five or six children. We were a big exporter of people. People were our major export. And of course, the world is full of mics and paddies. America, Canada, Australia, New Zealand...but there are also a lot of Irish in Argentina.

"Birth control was illegal. I remember when I was 16...I had a friend who wanted to sleep with his girlfriend. Since I was tall and looked older he asked me to go into a pharmacy and buy condoms. It was so awkward. I waited until there were no other customers in the shop. Then, I went in....trying to make my voice lower than it really was...and asked the middle aged woman behind the counter for condoms. It was so embarrassing. It's a wonder people had sex at all."

"People in Ireland are still funny about sex," said another Irish colleague. "My boyfriend and I 'lived in sin' before we got married. Everybody knew it. But 'living in sin' was not just a joke. People thought it was a real sin. They didn't really mind it, but they expected us to pretend we weren't sinning. So when my parents would visit we had to pretend we had separate bedrooms...even though it was obvious we were sleeping together.

"But nowadays, it's different. Now couples only have one or two children."

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Everyone We Know Expects a Fairly Quick Up-move in Inflation
• A Nightclub in the Middle of Rural France
• US Economy is Some 11 Million Jobs Short of Full Employment
• Are Stock Market Investors Really Such Optimists?
• Stock Market Continues Its Recovery

But poor Mr. Obama... He seemed like a nice enough fellow. More and more people seem to be mad at him.

What went wrong? It looks to us that he has been completely captured by America's two most special interests - Wall Street and the Pentagon. Maybe he was their man from the get-go; we don't know.

Yesterday, he announced that he was going to squeeze $120 billion out of the banks over the next 10 years. Don't worry about the bankers, dear reader; it's all for show. The feds pretend to punish the bankers and the bankers pretend to suffer. They'll whimper and whine...all the way to the bank!

How tough is it to make money when you can borrow money for nothing and lend it back to the lender at 400 basis points more interest? Even bankers can make money under those circumstances.

And that's not all. Don't forget that the feds are authorized to buy up Wall Street's mistakes...and to make sure that the bankers don't have to suffer from their own dumb mistakes.

Yesterday came news that the Fed had a very profitable year. It made more money even than Goldman Sachs - $45 billion. How did it make so much money? The papers report that it cleverly bought up debt that no one wanted...Wall Street's mistakes. And then, lo and behold...it turned the dross into gold. No kidding. Bad debt became good debt. And then it became great debt...as it became clear that the US government stood behind almost ALL DEBT issued by Wall Street's major players.

The financial press will spend a few days telling readers how smart the Fed is. Ben Bernanke will stress how the Fed saved the economy. Pundits such as Martin Wolf will claim they saved civilization.

But what is really going on? The Fed has a license to print money. Sometimes...when it can get away with it...it prints a lot of money. And it makes a lot of money. How cool is that?

And so, we turn to the story of Freddie and Fannie. The twins are double trouble, as far as we can tell. They lent (or guaranteed the loans) to people who couldn't pay the money back. Then, when the inevitable came to pass they told the feds that if they didn't help them out, America's entire financial structure would melt down...and almost every family in the country would find itself underwater.

In 2006, Fannie Mae set aside $519 million just in case things went bad. Things did go bad. And guess what. The half a billion Fannie had set aside turned out to be laughably inadequate. Today it has had to come up with ten times that amount...which is still not enough to cover the implied losses at today's market prices. It needs about twice that amount. So, along come the feds again...in a surprise move on Christmas Eve...with billions more.

We try to imagine members of Congress working hard to understand the complications of mortgage finance...giving the matter the solemn attention and fair-minded deliberation it deserves. After all, hundreds of billions of dollar were at stake. But try as we may, we just can't imagine it.

The pols didn't really try to figure it out. They didn't have to.

"You have no idea," said a source we won't divulge, "how much control the bankers - especially Goldman Sachs - have on government. They have their men in the key positions. And every politician and bureaucrat knows that if he goes along with the game he could one day get a job at Goldman and make millions. And I'm not just talking about the US. It's true of many other countries too. Goldman is international. And they've got their men in decisive posts in many countries."

One source of the bankers' power is money. The other is ignorance. They have money to throw around. When it comes to money, they seem to know what they are talking about. So, on Christmas Eve, 2009, rather than actually debate and deliberate, Members of Congress deferred to the bankers' lobbyists.

Who's going to argue with the bankers? They know how money works, don't they? What politician has the courage...or the knowledge...to stand against them? If they hadn't gone along with the bailouts, the whole shebang might have gone down the tubes, right?

Right...

Bill Bonner
for The Daily Reckoning Australia

• Warren Buffett is Buying Four Percent of Goldman Sachs
• Meredith Whitney and the Buy Recommendation on Goldman Sachs
• Government Sachs
• Fannie and Freddie in a Free Market Economy
• Rising in Defense of Goldman Sachs