We said we were doing some serious thinking this week. Maybe it is the season. But more and more, our thoughts become grayer. Less black. Less white. Less hard. Less soft.

A few years ago, it looked to us as though the world financial system had gone to war. We cheerfully awaited the victory parade. We figured Mr. Market would whup the feds good and hard. It hasn't happened so far.

On one side, are the forces of a natural market correction...following a long, long period of expansion. The easier money gets, the more people tend to misspend and mis-invest it. Then, inevitably, their mistakes must be corrected. That's what bear markets and recessions are for.

But the feds don't like bear markets or recessions. And at least since the Keynes outlined his general theory back in the early 20th century, they've believed that they don't have to put up with them. Keynes took a page from the Old Testament. Government should act like an enlightened Egyptian Pharaoh, he didn't say, but should have. It should run surpluses in the fat years and deficits in the lean years...thus flattening out the pattern of boom and bust.

Pharaoh was no dope. He stored up grain for seven years, when the harvests were bountiful. Then, when the seven lean years came, he released the grain to the people. Problem solved.

Keynes believed that modern government could do the same thing. But Pharaoh was not running a democracy. He had no voters to answer to. So, if he wanted to store grain in the fat years, he could do so.

In theory, the US government could do the same. But, in fact, it never runs significant surpluses. There are too many people who want too much bread and too many circuses. And you don't win votes by denying the voters what they want. So, in practice, the feds run deficits even in the fat years! Last year, before the downturn really started to bite, the US federal government ran the biggest deficit in history - nearly half a trillion dollars.

Now, let's imagine how that would work for a bad Pharaoh. He would give out grain in the fat years. This would encourage farmers to produce less grain. Then, when the lean years came, Pharaoh would have no grain to give out...and the farmers would have less grain stored up themselves, since they grew less during the boom years. The famine would be worse than ever.

Then, if we can imagine that Egypt was trading with China at the time, perhaps Pharaoh could borrow grain from the Zhou dynasty to help ease the peoples' pain. Perhaps he could mortgage the pyramids. Whatever, he - and the Egyptian people - would have been in much better position if he had done as Joseph told him in the first place...lay up stores in good times, then draw them out in bad times. How difficult is that?

But Bernanke didn't see the famine coming. Neither did Geithner. Or Greenspan. Or any of the other savants Pharaoh used to interpret his dreams. None of them expected hard times. None of them warned the public. None of them encouraged the government to save money for the recession. Nassim Taleb asks why Bernanke was reappointed after he clearly failed the most critical test. But heck...the federal government is an equal opportunity employer. Employees aren't let go just become they're incompetent.

Anyway, getting back to our thoughts...

..it looked like a battle to us - between the forces of inflation (the feds)...and the forces of deflation (the market). But battles usually have clear winners. One side is master of the field and the other retreats. One side is victorious; the other is defeated.

Alas, some wars produce no hosannas of success...and no wailing widows of failure. Some end in draws...or in confusion...or in disgrace and bankruptcy for both sides.

Like the bad Pharaoh, the feds saved nothing. Now, they have to try to work their Keynesian magic on credit. This puts them in a weak position; like a government that wages war on borrowed money. They can continue their campaign only as long as lenders allow them. They can't wage the war as effectively as they'd like. Then again, maybe they can't lose it as spectacularly as they might.

For the moment, their credit is still good. The bond market foresees an inflation rate of less than 2%. Bankers, taking money from the government, are happy to lend it back to them.

But the forces of the correction are giving up little ground. While stocks rally, the real economy remains in a funk.

"Sharp drop in start-ups," is a news headline from yesterday. New business start-ups are a major source of new jobs. Bad omen.

Even glamour publisher Conde Nast is forced to make cutbacks. It has told employees that they may not spend more than $1,000 a night when they are traveling.

A Pimco economist says savings rates are still going up...and may exceed 8%. This represents hundreds of billions of dollars taken out of the consumer economy. Oddly, while it makes the slump worse, it also helps finance the government's battle against it. Savers buy US debt (albeit indirectly).

So, the battle is still going on...and the outcome is still in doubt.

Bill Bonner
for The Daily Reckoning Australia

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First though, if you think Australia's entry into-deficit land doesn't eventually threaten its credit rating, let us take you back to the quiet London conference room of a hedge fund, circa 2003. Your editor was in the small crowd, along his friend and author Addison Wiggin, listening to an informative speech by a U.S.-based analyst on the "duration gap" between Fannie Mae's short-term liabilities and its long-term assets.

It may not sound that exciting, but what transpired over the next thirty minutes was a real eye opener. The analyst pointed out that if you borrow short-term and lend long-term, you expose yourself to changes in interest rates. You may have to refinance your debt at much higher interest rates, while the value of your long-term assets falls.

This was a problem, for the GSEs, the analyst insisted, because their assets-residential U.S. mortgages or mortgage backed securities-paid off over their long-term while their liabilities-the bonds they issued to finance their purchases of mortgages in the secondary market-were short term.

Even though the GSEs enjoyed lower borrowing costs than other corporate borrowers because of their implied U.S. government guarantee, he said, they would face higher borrowing costs if interest rates spiked. If that were to happen, the GSEs would likely be unable to grow their balance sheets or earnings. When your business is essentially borrowing money to buy mortgages, higher interest rates not only make borrowing more expensive, they also (as we've seen lately) affect the value of your assets. Higher interest rates meant death for the GSE growth model, he predicted.

For the GSEs, the rest has been history. While the financial media were busy glorifying the results of the bogus stress tests last week, Fannie Mae quietly reported a $23.2 billion first quarter loss (this followed a $25 billion fourth quarter loss). It also asked the government for another $19 billion in 'capital'. The company said, "persistent deterioration in housing, mortgage, financial and credit markets continued to adversely affect our financial results."

To his credit, the analyst in our London conference room saw all of this coming. After his presentation we stuffed a few canapés in mouth and asked him this question, "If what you said about the GSEs is correct, and the U.S. government is forced to make its implied guarantee of GSE debt explicit, wouldn't the increase in Federal liabilities threaten the U.S. credit rating? After all, you're talking several trillion dollars [at the time] in GSE debt. That would be a big increase in government liabilities."

"Oh. Well. Gee. I don't know about that. I mean, if that happened it would mean....well...it would mean..."

"The end of the dollar standard and the end of the dollar as the world's reserve currency?" we helpfully suggested.

"Well, yes," he chuckled. He seemed to regain his composure. "That's highly unlikely. I mean, that's a major development. It would be a big deal. That probably wouldn't happen. It can't, really."

"But isn't what you've just described exactly the sort of thing that could damage a country's credit rating?"

"Yes. But like I said, it's unlikely. I have to go."

Remember, that was before GSE liabilities exploded and the U.S. government-through the Fed and the Treasury-piled on trillions in new liabilities to deal with the global financial crisis. Fast forward to IOUSA star David Walker's article in Tuesday's Financial Times.

"Long before the current financial crisis," Walter writes, "a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us."

Moody's rating service warned last January that if the U.S. government made no policy changes with regard to Social Security and Medicare, "we would have to look very seriously at whether the US is still a triple-A credit." At the time, Moody's said that "look" would come in ten years time. But we reckon with the huge explosion in U.S. liabilities via the TARP and the budget deficit, that look may come sooner rather than later. And when it does, all bets about the value of U.S. liabilities (bonds) are off.

Here in Australia, the three credit ratings agencies (Moody's, Fitch, and S&P) say the prospect of a $58 billion Federal budget deficit doesn't threaten Australia's credit rating. Not yet it doesn't. But don't be surprised if the question comes up later this year.

We suspect that government tax takings will be smaller than the budget forecasts. And the budget assumes the economy will have "above trend" growth of 4.5% next year. And of course, no one is planning for a government-bailout of commercial property, residential mortgages, or the corporate bond market.

Maybe all that seems a little far-fetched right now, especially when Aussie companies have been successful at raising new capital through the equity markets and the private bond market. But in 2003, a roomful of investment professionals and money managers found it hard to believe the credit quality of the U.S. government was at risk from growing deficits. They were wrong, and those deficits are much worse now. That's the fate Australia wants to avoid.

With debtor governments tapping the global savings pool to rebuild public and private balance sheets (or just hand out money) it reminds us of another idea we discussed in London in 2004: that energy is becoming a kind of capital. Russia's new National Security Strategy reaches the same conclusion.

The Kremlin's policy paper says, "The international policy in the long run will be focused on getting hold of energy resources including in the Middle East, the Barents Sea shelf and other Arctic regions, the Caspian and Central Asia." It then added, rather ominously, "Amid competitive struggle for resources, attempts to use military force to solve emerging problems can't be excluded."

Energy wars can't be excluded. But for equity investors-and just for the people of the planet-it would be better if oil stocks rose because the market was bidding up the oil price as opposed to, say, a border war in one of the "stans" over oil and energy.

And as we've written in our "Long Aftershock" report, there are plenty of structural reasons in the oil market (collapsing capital spending in 2008) to believe an oil supply crunch is around the corner. Either way-macro-economically or geopolitically-the stars are aligned for higher oil prices. Naturally, NYMEX crude oil prices fell to just under $58 in New York trading on Wednesday.

Dan Denning
for The Daily Reckoning Australia

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In today's Daily Reckoning we take a merciless meat axe to the idea that progressive taxation has anything to do with fairness. Quite the contrary. There could be nothing more unfair than stealing from one man and giving to another based on his "ability to pay." But first, what's this about a budget deficit?

The fact that the budget is front page news (with extra sections of the newspapers) is a testament to how brainwashed and addicted to government the modern world is. Apparently we're all wards of the State now.

Should we really take these clowns this seriously? Sadly, we must, because they are not only spending their way into perpetual deficits, they are borrowing (stealing) from the future to do so. Aside from being ham-fisted economic ineptitude, it is also cowardly, immoral, and intellectually offensive. It also affects markets and your investments. More on that in a moment.

Let's get through this ugliness quickly. Next year's budget (2009-2010) predicts a $58 billion deficit (5% of GDP) with over a million Aussies out of work (unemployment peaking at 8.5%). The government will spend $22 billion on 'nation building' projects, including $8.5 billion on roads, railways, and ports, $3.5 billion on 'clean energy,' $2.6 billion on universities, $3.2 billion on hospitals, and $4.2 billion as a down payment on the national broadband network. It will sell $60 billion worth of bonds by next June to pay for all of this.

The government also says that Australia's net debt will peak at 13% of GDP in 2014, and that compared to 80% in other developed economies that is just awesome. And by then, spending can but cut to the bone because the economy will be ticking along at 4.5% annual growth with jobs returning. By 2015 or 2016-presumably in its third term-the government will return Australia's public finances to surplus, or they will be utterly ruined. Place your bets.

We reckon that tax takings will be lower, unemployment higher, and economic growth much worse than the budget forecasts. The net debt figure will not stabilise at 14% of GDP. Australia's entitlement mentality (remarkably like America's, and also encouraged by both major political parties) will push spineless politicians down a path of spending increases financed by more and more borrowing and more and more taxes (think carbon, baby).

It's not too late to stop the debt train and get off. But you'd have to challenge the idea that it is the proper role of government to 'combat' a recession by a 'temporary' slide into deficit spending. There is nothing temporary about it. Deficits are political animals and once born, they somehow keep growing to monstrous, productivity-destroying sizes.

Wayne Swan says cutting spending and government services during a recession would be 'crazy.' We say the whole idea of transferring billions of dollars to stimulate consumption is even more insane. If you want the economy to recover, let people keep more of their own money and do what they want with it. Then let the marketplace adjust and quit propping up businesses that can't survive. This would restore the economy to a sustainable path of growth determined by consumer choices and not government intervention in household and corporate finances.

But hey, that would be a free market working like a free market. And that's just 'crazy.'

In other budget news, the $21,000 first home buyer's grant for newly built properties has been extended past June 30th to September 30th. The $14,000 grant for existing homes has also been extended to September 30th. Between October 1st and December 31st, the grants will be reduced to $14,000 and $10,500 respectively. And next year, they will revert to measly $7,000 figure for each that John Howard set when he introduced the subsidy to the real estate and building industries in 2000.

Both the Howard and Rudd governments will rue the day they subsidised higher house prices with government handouts. It's going to impoverish a whole generation of Australians, making them house poor and mortgage-debt rich. Why?

House prices do fall. They don't double automatically every seven years. If we had a three-bedroom house for every time we heard that in 2004 we'd be incredibly house rich. In the U.S., the National Association of Realtors reported that median U.S. house prices fell 14% in the first quarter of 2009 compared to last year. Existing home sales also fell by 6.8%

It was the largest quarterly decline in U.S. house prices ever reported. Of the 152 metropolitan areas surveyed, prices fell in 134 of them. The price declines were especially shocking in places where the boom was greatest In the Cape Coral-Ft. Myers area of Florida, prices fell 59%. In Saginaw, Michigan they fell by 54%. In Akron, Ohio they fell by 48%. And in San Francisco, they fell by 43%.

There are people who tell you those sorts of declines could never happen in Australia. But those people are morons. A contraction in bank lending, a rise in unemployment, a restriction on immigration, and a rise in interest rates remove all the props that have supported the soaring Aussie property market up until now. If you don't think it can happen here, you're kidding yourself. And if you disagree, send us a note at dr@dailyreckoning.com.au and tell us what you think of the chart below.

Source: www.whocrashedtheeconomy.com

In resource-related news, did you see this number? Chinese urban fixed asset investment was up 30.5% in the first quarter. The National Bureau of Statistics said investment in rail and "other transport" was up 94.2% for the period. Could this stimulus spending account for the surge in Aussie iron ore exports we mentioned earlier this week? Hmmn.

Lots of mail about why we never write about silver or other rare metals. Oh but we have! We don't usually do it here. But we have done it Diggers and Drillers, where we've also recommended a few ways to invest in it. Jim Rogers, incidentally, likes silver, platinum, and palladium as well.

Finally, if you are easily offended, you should remember that living a free society does not protect you from the offensive ideas of others. In fact, it's just the opposite. It means that in a free society, you can't shut people up just because you find their ideas challenging, offensive, or because, in the touchy-feely language of the day, they make you feel "uncomfortable."

That's all a preamble to the idea that societies that use tax law as a way to achieve political or social goals are societies based on envy and resentment. That is, how a nation treats taxes tells you something of the character of a nation.

So when you hear Wayne Swan-or anyone for that matter-say that the level of taxation in a country should be based on the "ability to pay" be very afraid. These people are not only coming for your money. They're coming for your economic liberty too. Ultimately, that means they're after your political liberty as well.

Progressive taxation is the idea the larger your disposable income, the larger percentage of that income you 'should' pay in taxes. Proponents of it-and these days nearly everyone one is-claim it is more 'fair." But let's be honest and call things by their right names and say what progressive taxation is really about.

Even John Stuart Mill, who favoured it, called progressive taxation "a mild form of robbery." That's because progressive taxation about using the tax code to redistribute wealth. It's base on the class-warfare idea that the rich get rich illicitly and conspire to keep the riches of society for themselves. It uses the law (coercion) to correct what some people see as the social and economic injustice meted out by the marketplace.

But how people treat private property (and wealth IS private property) determines the character of society. A society that promotes the idea of wealth accumulation and that everyone can get rich is one in which standards of living will rise over time. It doesn't mean getting wealthy is the only or even the most important ambition in life. That's a matter of personal choice and values. But it just means that if you want to raise standards of living over time, you should guard economic liberty and not use taxation to punish personal incentives.

The only fair argument for progressive taxation is that indirect taxes (consumption taxes) hit the poor harder than they hit the rich. This is certainly true for taxes on consumption goods. But it is not true for income taxes, most of which the poor do not pay anyway. A tax on Gucci handbags is less onerous than a tax on a slab of beer. But that doesn't justify the argument that just because you can pay more taxes, you should.

When is it ever right for a man to come in to your home and take what's yours simply because he'd decided that someone else needs it more? And how is the government arbitrarily deciding to raise income tax rates on only certain citizens, based on their ability to pay, any different? Yet that's the argument for progressive taxation in the modern world. And most people seem to think it's fair and just.

Mind you, that doesn't mean that free people can't use legislatures to levy taxes in order to pay for projects they believe should be provided by the State, like roads, bridges and other infrastructure. But there is a difference between that kind of public spending and public spending financed by wealth redistribution to achieve particular social and economic outcomes.

How did we get to the point in civil society where a democratic majority that does not pay taxes can, through its elected representatives, legally confiscate the wealth of a minority? Friederich Hayek gives the history in, "The Constitution of Liberty."

"As is true of many similar measures, progressive taxation has assumed its present importance as a result of having been smuggled in under false pretences. When at the time of the French Revolution and again during the socialist agitation preceding the revolutions of 1848 it was frankly advocated as a means of redistributing incomes, it was decisively rejected. "One ought to execute the author and not the project," was the liberal Turgot's indignant response to some early proposals of this sort.

"When in the 1830's they came to be more widely advocated, J.R. McCulloch expressed the chief objection in the often quoted statement: 'The moment you abandon the cardinal principle of exacting from all individuals the same proportion of their income or of their property, you are at sea without a rudder or compass, and there is no amount of injustice and folly you may not commit.'"

"In 1848," Hayek continues, "Karl Marx and Freidrich Engels frankly proposed 'a heavy progressive or graduated income tax' as one of the measures by which, after the first stage of the revolution, 'the proletariat will use its political supremacy to wrest, by degrees, all capital from the bourgeois, to centralise all instruments of production in the hands of the state.' And these measures they described as 'means of despotic inroads on the right of property, and on the condition of bourgeois production...measures...which appear economically insufficient and untenable but which, in the course of the movement out strip themselves, necessitate further inroads upon the old social order and are unavoidable as a means of entirely revolutionising the mode of production.'"

If Marx and Engels are to be taken at their word, progressive taxation was never about fairness. It was about putting production "in the hands of the State" and "revolutitionising the mode of production." In the world of State-run capitalism, this is what we seem like we're headed towards.

Now, we can take a step back and ask whether a State-run, union owned Chrysler makes a better car than the shareholder owned management-run Chrysler. It's a fair enough question. We'd argue that government-built and designed cars are going to be about as appealing as a leather boot for breakfast. But that is not really the point.

The point is that the politicians are lying to you about the goal of progressive taxation. The goal is not to produce more "fairness" or "social justice." It's to place the State at the centre of economic production, so it can regulate and tax with impunity.

There both a psychological and crassly economic motive to this movement to displace the free market with the State as the organiser of economic life. The smarty pants elitists in both political parties, with their ties to union and corporate money, really believe the world would be better off it was run be benevolent bureaucratic despots. Or maybe using coercive taxation to steal from the rich is simply envy-based class politics, a kind of populist theft conducted with the consent of a hi-jacked system for passing laws.

Once you go down this road of socking it to the rich instead of reducing spending, you get higher and higher rates of taxation that eventually shrink the economy. Britain adopted the income tax in 1910 and the U.S in 1913. At the time, the top tax rates on income were 8.25% and 7% respectively. Yet within 30 years, thanks to the Great Depression and the World Wars, those rates had risen to 97.5% and 91% respectively.

"Thus in the space of a single generation," Hayek writes, "what nearly all the supporters of progressive taxation had for half a century asserted could not happen came to pass...All attempts to justify these rates on the basis of capacity to pay was, in consequence, soon abandoned and supporters reverted to the original, but long avoided, justification of the progression as means of brining about a more just distribution of income."

How much a man should reasonably a pay to the State was no longer an economic question about his 'ability to pay.' It was revealed as the purely political decision it always was. Or as Hayek says, it's "an attempt to impose on society a pattern of distribution determined by majority decision."

That's what we meant by the character of society. Do you want to live in a country where over 50% of a man's income can be taken from him simply because the majority votes for it? In that kind of country you want to live in, where you have no real property rights and you don't have equality before the law.

Upward income mobility is undermined in this kind of society. People don't try to get rich because there's no point in it if your gains are going to be confiscated. The net result of decades of progressive taxation is lower capital formulation, more consumption, less production, and ultimately a lower standard of living for everyone.

In that society, your only means of social and economic advancement is based on your personal connections and political patronage. Not surprisingly, in that society, politicians exercise enormous power. And decisions are not made by businesses who aim to offer consumers better products and services at lower prices. They are made by politicians who aim to cement their electoral position by favouring certain constituencies.

Progressive taxation has nothing to do with fairness, justice, or equality. It is unfair, unjust, an unequal. But hey, if that's the kind of country you want to live in, or if you're someone who's getting the check instead of writing it, that might not seem like such a bad deal.

We'd just advise you to prepare for a lifetime of dependency on busy body politicians who become increasingly grasping, moralistic, and intrusive. If you're a free man, you'd better pack your bags and look for some other luckier country.

This is not to glorify getting rich as the most important thing in this world (or any other world.) It isn't. And there are much more important things in life. Whether you choose to pursue material gain is up to you.

And just as a government should not use the tax code to punish the rich, it ought to quit tinkering with it and providing so many deductions and rebates that allow anyone with a good accountant to avoid paying large income taxes. A much simpler taxation system based on consumption would be fairer for everyone and it would force the government to finally live within its means.

Of course that probably won't happen. Ever. But it would be nice to think so. In the meantime, a society that discourages wealth creation and capital formation through so-called progressive taxation is eventually going to make itself a lot poorer and a lot less free.

Dan Denning
for The Daily Reckoning Australia

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Oh wait. We forgot about the 'stress tests.' Remember that's the official government report of how the 19 largest U.S. banks would hold up under further loan losses or asset write downs. It's designed to give investor (and the banks) a transparent picture of how much capital the banks need to be unequivocally healthy.

Actually, it's not designed to do that at all. The 'stress tests' are a white-wash. There's no way the government would release a report to the market that said the banks were in horrible shape (insolvent) and needed billions more in capital to make up for billions of losses in residential and commercial real estate.

That means either the 'stress tests' were a bogus exercise in deception. Or, to the extent they uncovered anything legitimate, it will be leaked in the press and priced into the relevant banks shares before the tests ever hit the public. Besides, the 'stress test' began in 2007. The market's already told us what it thinks of the banks.

One more quick note on commercial real estate. Is it still 'the other shoe to drop' on the banks this year? Maybe it already dropped! The Guardian reports that, "Global sales of investment grade real estate plunged 73% to $47 million in the first quarter from a year ago, or just one-sixth of the level two years ago, according to real estate research firm Real Capital Analytics on Friday."

A 73% cliff dive is as good as a crash in our book. But that figure only refers to new sales. There is a lot of existing debt that has to be refinanced. "Making things worse," the Guardian adds, "the number of properties that need to refinance or need capital infusions is soaring. New reports of defaulted mortgages and failed commercial property companies surpassed $55 billion in the first quarter, bringing the total known distressed commercial properties to $153 billion."

This is one reason to remain suspicious of property and financial stocks this year. In fact, you can pretty much bank on the idea that these stocks will never lead the market again in the way did over the last five years. The sector that leads the market up in a credit boom never really fully recovers as the best-performing sector (think tech stocks).

One thing to watch for? The financial sector and state governments using the Federal wholesaled funding guarantee to trash the country's international credit rating. Macquarie Group used the Fed guarantee to raise $14 billion on international debt markets at the end of the financial year. The company has already set aside $200 million to pay the Feds for the use of the guarantee this year (think about that for a second, this government is 'selling' its credit rating for $200 million).

Macquarie is raising capital this way, "Mainly because Macquarie could actually save money on its deals because it did not have to rely on its lower (and therefore higher risk-rated) single "A" credit rating. Analysts have estimated Macquarie's benefit at $580 million for every $10 billion of new debt raised," reports Danny John in today's Age.

To be fair, Macquarie is also raising money from equity investors too. After announcing write downs that slashed its full year-profit in half, the company told the ASX it had sold $540 million in new equity to institutions. So here's the question...what is the bank loading up for?

By 'loading up' we mean that it's essentially re-arming itself to get back in the market...and do what? "Macquarie is already aiming to build a global stock-broking business centred on Asia, London and New York and to become significantly bigger in energy trading, specifically in oil and gas. It plans to buy new businesses and increase its existing operations with capital injections on the other side of its balance sheet."

Hmm, oil, energy, and Asia? That sounds like a strategy based on decoupling. Remember that? It was the idea that the credit crisis would hurt the U.S. and Europe but not so much the emerging market countries. But it depends on what you mean by 'hurt.'

Equity investors everywhere were 'hurt' in the last 18 months. Nowhere was safe. Nothing was decoupled. So now the question is which economies will recover first: the high-saving emerging markets with growing populations and rising incomes, or the highly-indebted industrial economies that are going even deeper into debt to bail out financial institutions (this is not a trick question.)

By the way, Western governments have been so fixated bailing out their banks they haven't noticed how Chinese banks and companies are providing critical capital to world-class mining projects. China picked up another valuable pebble when China Non-Ferrous Metal Mining Company picked up a controlling stake in the world's largest non-Chinese rare-earths producer for the paltry stake of $505 million on Friday. We'll have more on the sad strategic case of Lynas Corporation tomorrow and whether there is good news buried in the story of Aussie resource investors.

Is it fair to blame the government for leaving strategic assets hung out to dry? That's debatable, and the Treasurer still has to sign off on this deal. But obviously the government has other problems on its mind. On Friday, Treasurer Wayne Swan said government 'revenues' would be about $100 billion less than he expected with last May's budget.

What does all this lead to? We reckon the combined burden of Federal, State, and government-guaranteed bank borrowing is going to put a lot of pressure on the Aussie dollar and lead to higher interest rates. State governments are already under pressure. "Victoria may lose its prized triple-A credit rating as the State Government pushes the state deep into debt to fund new roads, railway lines, hospitals, schools and water projects, one of the big four banks has warned," today's Age reports.

The Wall Street Journal (and international investors) are on to the story too. The Journal reports that, "Australia's major states are all expected to post in the next six weeks a significant deterioration in their fiscal positions, strengthening expectations of a surge in state government bond issuance. A dramatic erosion in traditional revenues from land taxes and mining royalties will be a common theme for all states."

Dan Denning
for The Daily Reckoning Australia

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Or maybe not. We'll just have to see. Either way, if Tim Geithner's plan sends the market down five percent or more this week, we reckon it's his last week on the job, which may be a relief to Mr. Geithner.

Kevin Rudd conceded that Australia's economic fate is largely tied to forces beyond its control. In an interview with Channel Nine over the weekend he said, "A worsening global economic recession will make it virtually impossible for Australia to sustain a positive economic growth for the period ahead, with impacts, of course, for budget and employment."

Of course. That means, by the way, February's unemployment rate of 5.2% (the highest in four years) is probably headed higher. Not having worked in the private sector recently (or ever?) the Prime Minister may be underestimating how many of Australia's businesses are prepared to shed jobs amidst uncertainty. "More than half of Australia's mining and resource companies will fire staff in the next 12 months," Bloomberg reports.

The "budget impact" will be a higher government deficit. True, it won't be as bad as the A$13 trillion U.S. deficit over the next ten years. That's what the Congressional Budget Office is projecting if Barack Obama's spending plans go through Congress unchecked. It's massive.

But a deficit is a deficit. The money has to be borrowed from someone. And it has to be paid back later, through higher taxes or more borrowing (not to mention the interest). It's not a good habit to get into, living above your means because you are unwilling to cut back on your lifestyle.

In any event, the big news this week will be how markets receive U.S. Treasury Secretary Tim Geithner's toxic asset plan. By all accounts, it sounds like Geithner wil make US$1 trillion (or thereabouts) available to hedge funds and private investors in order to buy aforesaid toxic assets from America's banks.

"Here. Take this $1 trillion. Buy those bad assets. Benefit from the upside. We'll take all the risk...What's that? Why yes, of course I'm serious."

If you've been paying attention to the way the U.S. Congress treated AIG executives during hearings last week, you'll wonder why anyone of sound mind would want to become a business partner of the United States government. It's a government that is now willing to change the laws to punish people of whom it disapproves. And before that, it's a Congress that was willing to pass a thousand page stimulus package that no one had read.

Does anyone really believe these idiots have any idea what they're doing? And does anyone believe private capital will hold hands with Uncle Sam and take his borrowed money to buy toxic assets?

On the face of it, using someone else's money to take risk doesn't seem so bad. But given the last few weeks in Washington, private investors would have serious doubts about whether any profits that might result from owning those assets would actually go to investors, or would be confiscated by the Congress. "Political risk" is the kind of investment risk you used to associate with dictatorial regimes in Africa, not democratic regimes on the Potomac. But there's no doubt investors in America (like China and its US$700 billion in bonds) now face real political risk.

All of which is to say that the government is making investors more nervous and more risk averse. This is not the kind of indifference that comes with bottoms. This is the kind of panic that comes with crashes. There's a chance that could change that week if the Geithner plan is well received and the morons in Congress put down their pitchforks. But if it doesn't change for the better, it could change for the worse.

And even assuming the plan is well received, banks are still going to need more capital before they begin lending again. Former Fed Chairman Alan Greenspan told investors at a conference in Acapulco Mexico that, "Restoration of normal bank lending will require a very large capital infusion from private or public sources."

He puts this number somewhere "north" of US$750 billion.

A trillion here. A trillion there. Pretty soon you're talking about a bankrupt America.

What all this means for Australia is still not quite clear. Australian banks are still lending for new mortgages and they don't, on the surface anyway, appear to be having any trouble borrowing money themselves. We're keeping an eye on both (lending and borrowing by the Big Four).

The huge American deficits make the U.S. dollar weak. The Aussie has been rising, as have gold and oil. Greenback weakness is commodity bullish (not across the board though). And Australia is not one of those countries that has pegged its interest rates to U.S. rates. That means Australia does not have to match U.S. rate cuts to keep its currency pegged (as is the case in some of the Gulf States, China, and other places).

So the good news is that Australia does not necessarily have to import inflation from the U.S. The bad news is that economic conditions are getting worse, not better, meaning that inflation might get to these shores anyway. If unemployment rises, stocks stay flat, and trade weakens, it wouldn't surprise us to bigger government deficits with larger spending plans and more rate cuts. Growth in the money supply is inflation. It shows up later in higher prices.

And for housing? That's what many Aussies treat as "Plan B." It could be that you see a resurgence in house price inflation as Aussies turn away from the share market in favour of the myth of perpetually rising house prices. Although it may look appealing for awhile, it may not end well.

Two or three years down the track-maybe sooner if unemployment grows faster-we can see the Reserve Bank in the position of having to raise rates to contain inflation. It will have done so after hundreds of thousands of younger, marginal buyers have been sucked into the housing market with First Home Buyer grants. How will they cope with rising rates? How will they cope with falling prices? How will they cope with losing their jobs?

"Australia has certainly been a levered play on this global commodity boom and if we truly had been in a super-cycle, then it was a brilliant move," Stephen Roach of Morgan Stanley says. "But the global commodity boom has also gone bust, and this has caught Australia without much in the way of a diversification or a backup plan."

More on how to actually diversify tomorrow.

Dan Denning
for The Daily Reckoning Australia

• The Geithner Plan
• Australia’s Response to the U.S. Bailout Plan
• America’s Debt Woes
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way

--Here in Australia, bad news rolls on in the labor market. Pacific Brands is sacking 1,850 jobs in Australia in a bid to boost its fortunes. Profits got to shareholders, and shareholders are Australians who also wear underwear. Thus a dilemma, what if what's good for Australian shareholder s in general is bad for the 1,850 workers of Pacific Brands who won't be making jocks any longer? Which group should be favoured?

--Discuss. Our answer tomorrow. Hint: even if we all went out and bought a pair of bright pink Bonds today, it wouldn't solve the company's problem.

--The share market is digesting the ambitious speech Barrack Obama gave to the U.S. Congress. He's going to cut the U.S deficit in half, increase spending, provide universal health care, improve education, replace oil with alternative energy, introduce a carbon cap and trading scheme...and that's just before lunch!

--You have to wonder what kind of Kool Aid the folks in Washington are drinking. Do they not realize that the nation which they claim to represent is actually going bankrupt? The U.S. government has already made too many promises it can't keep. Making more isn't going to improve things.

--But in a democracy, the people demand action and handouts and a plan! So give it to them good and hard, as H.L. Mencken would say. They're going to get a plan alright. And it's going to involve borrowing lots of money.

--It's no wonder the stock market is depressed. You half expect Mr. Market to take sickie and spend the day at the pokies. Or drinking gin.

--It's optimistic, but there's a chance the status quo could be maintained for about six months. You'd have a directionless market, a range-bound gold price (between US$900-$1,000) and a steady drip of negative economic news. Why six months?

--That brings us to the Capital Assistance Plan (CAP) announced yesterday by the U.S. Treasury. The CAP is designed to solve the problems in the U.S. banking sector. It aims to do this by given the appearance of thorough audit of bank assets and capital requirements (under different scenarios) and then giving the banks six months to raise additional required capital in the private markets, or, to sell convertible preferred shares to the government at a yield of 9%.

--The first part of the plan makes plenty of sense. Behind closed doors, regulators want to meet with the banks and take a good hard look at the books-ALL the books-and see if the banks have adequate capital to survive if the economy contracts by another five percent this year.

--In its white paper on the program, Treasury states that, "In their assessments, regulators will incorporate off- balance-sheet commitments, earnings projections, risks of the banks' business activities and the composition and quality of their capital." Once that's done, the banks, the Treasury, and most importantly, private investors should have a reasonable idea of how much capital the banks need.

--You can see what the Treasury is trying to do. And it's headed in the right direction. Treasury believes that if the banks can provide the marketplace with an audited and accurate statement of their risk going forward, cashed-up private investors might be more than willing to provide capital. Transparency leads to freer flowing investment.

--That's what they must be hoping anyway. One problem we can think of right away is that there are two scenarios used to determine capital requirements and adequacy, a "baseline" scenario and a "more adverse" scenario. The "baseline" scenario reckons on a 2% contraction in U.S. GDP this year and 2.1% growth next year. The "more adverse" scenario reckons on a 3.3% contraction this year and a 0.5% expansion in 2010.

--Does this make sense, though? GDP could expand this year by virtue of the government stimulus package. You'd have the illusion of more economic activity without any actual improvement in the quality of banks assets (which remains the core issue).

--Besides, maybe Treasury should include a "really adverse" scenario in which GDP contracts by 5-10% this year. After all, all over Asia GDP is falling like a stone as exports decline and industrial production cliff dives. America is not going to export its way out of a slump when its trading partners are faring even worse.

--And another thing. U.S. existing home sales were down 5.3% in January. Median prices are down 14.8% year over year to a suddenly intriguing US$170,300. Now, if people could just get a loan! Seriously. Prices are reaching that "clearing" level where you might see an uptick in demand.

--But the Treasury plan probably does not include a contingency where house price fall another 10%. If that's the case, the banks will need more capital than you can imagine. And remember, it's not going to come from savings. It's going to come from money the Treasury gets by borrowing, raising taxes, or from the Fed.

--Inflation. Get ready for it. Now or in six months. It's the only real way to grow GDP, although it will be bogus growth. Six months. IN the meantime, maybe the market will buy this plan. Or maybe it will be left in a state of uncertainty. That gives you time to execute your own plan. More on that tomorrow.

--Finally, our apologies to the alligator fruit! We had no idea...really...very sorry. Eat more!

--Dear Folks,

Offering a fellow who's dying of coronary artery disease a cheeseburger with bacon certainly wouldn't help, but you got it WRONG about the AVOCADO!

There are "good fats" and "bad fats". The bad fats clog your arteries and cause clots to form, resulting in heart attacks, strokes, and other nasty things. The good fats prevent these things.

Saturated fats such as are found in beef fat and cheese are bad fats. Trans fats, such as are found in lard and the oil used for deep frying French fries are even worse - as they cause inflammation of the clogged arteries - clots tend to form on areas of inflammation. It's the clot which completely blocks blood flow in the artery - which does you in - not the hardening of the artery.

Medium chain triglycerides are good fats - they do not harden arteries and decrease arterial inflammation. They are found in plants - mostly in seeds. Examples of medium chain triglycerides are - ta da! - avocados, most nuts, sunflower seeds, canola (formerly called rapeseed but that was deemed politically incorrect - I couldn't make this up!) oil, olive oil and flaxseed oil.

So there you are - go forth and eat your avocados!

Best -

John D. Foster, M.D.
Atlantic Beach, Florida
U.S.A.

Dan Denning
for The Daily Reckoning Australia

• Slipstream Trader: How to find small cap gains from large cap stocks
• Australia’s Response to the U.S. Bailout Plan
• U.S. Government Takes Over the Economy
• How U.S. Mortgage Rates Affect Aussie Stocks
• CNOOC Signs Agreement With Altona (LON: ANR) for Coal to Liquids Project

Our old friend, Lord Rees-Mogg, writes in the TIMES :

"Daniel Webster's opinion should never be forgotten. Of paper money he says: 'We have suffered more from this cause than from every other cause or calamity. It has killed more men, pervaded and corrupted the choicest interests of our country more, and done more injustice than even the arms and artifices of our enemy.'

"In the 1930s some nations tried to beat the slump by competitive devaluations. In the present crisis, Britain has already experienced a very big devaluation of the pound, taking it down by a quarter against the dollar. Every country, led by the United States, has been issuing money, often in very large amounts, in order to bail out its banks. No one knows the total value of these national injections of cash into the banking systems. As the earlier injections have not restored stability to national economies, further injections inevitably will be made. All will be made in unconvertible currency, and over-issue will occur.

"Governments need to create a new world system, in which gold, as a stabiliser, should play its part. For individuals, gold remains the best insurance against future shocks and the best store of value."

Yesterday, the Dow fell another 297 points...as the market continued to react to Obama's $787 billion bailout. "Too little," say some. "Too late," say others.

But the worst may not be over for this market. Earnings are falling...for the very simple reason that people are spending less money. People spend less. Business makes less. Lower revenues; lower earnings. As we mentioned yesterday, for the first time in history, S&P stocks are losing money.

Savings rates are climbing in the United States. The trade deficit is falling. These are healthy trends for the long run. But they are hard to take in a depression.

Not only are earnings falling, P/Es are falling too. Stock prices are adjusting not only to the lower earnings, but to the new psychology of a depression era. There are times when people will pay $20 for one dollar's worth of earnings. Other times, they'll be reluctant to pay even $5. We've seen the $20 figure as recently as a couple years ago. Now, the trend is moving in the opposite direction. We're headed towards 5 bucks. That's what people will pay for $1 of earnings when this market finally reaches its bottom. Or thereabouts.

The combination of falling earnings and falling P/Es does to stock prices approximately what the Romans did to Carthage in the third Punic War. That's why we have our Crash Alert flag flying. Stock prices delenda est.

Typically, depressions come with bear markets. And bear markets come with bounces and rallies. We expected an O! Bama! bounce after the election. We got one...but much less than we expected. Stocks only rallied about 15%.

A stronger bounce will come, sooner or later. But we've put up our Crash Alert flag again - just in case. Stocks could go down another 30% - 50% first.

The news from the economy is not all bad. The shipping index has rallied - up 147% from its bottom. So, somebody must be moving something.

Beyond that, the headlines are grim. The automakers are headed down a dead end road, say the papers; they say they need $18.5 billion. Where are they going to get that kind of dough? The corporate bond market - to which corporate borrowers turn to raise money - is dead. When it comes to borrowing money, private borrowers just can't compete with the U.S. federal government. Even the states can't compete; they don't have printing presses either. California is facing a "lockdown" of public services, Bloomberg reports.

All over the world, the search for the bottom continues. Ireland seems to be edging towards default. And Japan is in a "dreadful state," says the Economist .

Things are so bad in Japan that the finance minister, Shoichi Nakagawa decided to drown his sorrows in drink. Alas, he chose the G7 meeting - at which he represented his country - to get drunk. Now, according to the New York Times , he is being forced to quit.

From what we can tell, Nakagawa is the only G7 finance minister who should stay on the job. The rest of them clearly don't know what's going on. Otherwise, they'd be drunk too.

*** Gold, as Lord Rees-Mogg notes, is the "best insurance against future shocks." A lot of people seem to think so. Gold rose $25 yesterday, to $967, and soon will be crowding $1,000 an ounce again.

Technical analysts are warning that gold is headed for a correction. "What should we do?" asks a colleague. "It looks like gold might go down in the near-term...but we don't want investors to sell out and risk being out of the market when the big move comes."

Unless you enjoy the thrills and spills of trading in and out, we don't recommend that you try to time the gold market. It's too treacherous. Yes, gold may go down in the next few months. But that has been true for the last 10 years - ever since we began recommending it. It goes up. Then, it corrects. And then, before you know it, it goes up again.

We don't think that pattern is going to change anytime soon. Gold is in a bull market that will only end when the final bubble pops - the bubble in paper money. How that will happen is anyone's guess. When it will happen is a matter of guesswork too. But the dollar delenda est too. In the meantime, we hold onto our gold and await developments.

And we suggest you do the same. Yes, the price has gone up in the past couple of days...but that doesn't mean you can't still get the yellow metal at a bargain. In fact, you can still buy an ounce of gold with the change you find under your couch cushions...no joke. Learn all about penny-per-ounce gold here .

*** Here's an interesting little item: "US Military Will Offer Path to Citizenship," says the New York Times . Why not? It worked for the Romans - for a while. Then, when the barbarians in the ranks became numerous and powerful, they took over.

Richard Florida, writing in The Atlantic :

"'One thing seems probable to me,' said Peer Steinbrück, the German finance minister, in September 2008. As a result of the crisis, 'the United States will lose its status as the superpower of the global financial system.' You don't have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire - the fall long prophesied by Paul Kennedy and others.

"Big international economic crises - the crash of 1873, the Great Depression - have a way of upending the geopolitical order, and hastening the fall of old powers and the rise of new ones. In The Post-American World (published some months before the Wall Street meltdown), Fareed Zakaria argued that modern history's third great power shift was already upon us - the rise of the West in the 15th century and the rise of America in the 19th century being the two previous sea changes.

"But Zakaria added that this transition is defined less by American decline than by 'the rise of the rest.' We're to look forward to a world economy, he wrote, 'defined and directed from many places and by many peoples.' That's surely true. Yet the course of events since Steinbrück's remarks should give pause to those who believe the mantle of global leadership will soon be passed. The crisis has exposed deep structural problems, not just in the U.S. but worldwide. Europe's model of banking has proved no more resilient than America's, and China has shown that it remains every bit the codependent partner of the United States. The Dow, down more than a third last year, was actually among the world's better-performing stock-market indices. Foreign capital has flooded into the U.S., which apparently remains a safe haven, at least for now, in uncertain times."

We remember our Five Big E's from a couple of years ago.

They were the underlying trends that we thought were unstoppable. Let's see...

1. Our Experimental money system - with faith-based paper dollars at the foundation - was doomed
2. The U.S. Empire was peaking out
3. Energy was becoming more expensive
4. Wealth and power were moving to the East.
5. And the Economy was headed for a crisis.

The only one of those that looks like a bad bet is number 3. Energy is a lot cheaper now that it was a year ago. But does that mean that the trend towards more expensive energy is over? Maybe...maybe not.

The price of crude oil dropped below $35 this week. Yesterday, it traded at about $37.
"I think we've seen the bottom," says colleague Simone Wapler.

Simone explains that many of the projects that were supposed to bring more oil on line have been abandoned. That will mean shorter supplies than forecast. Economic growth forecasts have been cut too...which will cut consumption. But inevitably, Asian economies will grow...and they will use more energy. There are 700 cars per 1,000 people in the US, she points out. In China, the figure is barely 20. One way or another, Asia is probably going to use more energy in the future...which is probably going to increase the price of oil.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

P.S. Colleague Byron King warns that although it's easy to be lulled into believing that low energy prices are here to stay, he wouldn't get too used to the idea. In fact, Byron thinks we are heading into what could easily be the most vicious and unpredictable financial cycle of the past 150 years. Learn how to prepare yourself (and even profit) from the 'forever oil crash' by clicking here .

• All the World’s Stock Exchanges are Now Officially in Bear Markets
• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Your Second Chance to Escape the Bear Market
• Foreign Investment in Australia, How Much is Too Much?
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings

Mr. Luo Ping, director general at China's Banking Regulatory Commission, speaking in New York on Wednesday, shared his opinion of U.S. bailout policies:

"Once you start issuing $1 trillion-$2 trillion ...we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do."

Reports in the press this week say that China is considering ways to diversify out of the dollar. The Chinese are no fools. They see what is coming. And they know what it will do to them - the holders of the largest pile of dollars ever assembled.

The Financial Times made it perfectly clear to them in a cartoon yesterday. It shows Barack Obama in front of a huge smoking trashcan filled with dollars. The president is pouring on gasoline.

Yes, dear reader, Mr. Ping has caught on. And the rest of the world is catching on too. The feds are printing trillions of dollars...and dumping them in banks and zombie corporations. They've got out their Zippo lighters...their firestarters...their kindling and crumpled paper.

But getting this blaze going is harder than most people think. It could take months...or even years.

Yesterday, the Dow held steady. But oil continued to sink. The price per barrel fell below $35.

France is officially in recession, says today's La Tribune . GDP fell at a 1.2% rate in the last quarter, the government announced. A decline of 1% is expected for 2009.

Spain is in a worse recession. Property sales are off 30%. The GDP is expected to decline 3.3% this year. And unemployment is projected to reach 19% by 2010.

"Falling like a rock," says La Tribune of Spain's economy.

Meanwhile, "India set for slowest growth in six years," says the FT .

"Austria warns of dangers in potential Ukraine 'catastrophe,'" continues the gloom and doom.

And in Japan:

"Deflation fears grow as wholesales prices fall."

"Pioneer lays off 10,000 workers..."

World trade is collapsing. Now everyone is complaining about 'protectionism.' The next G7 meeting has protectionism - and how to avoid it - at the top of the agenda. But protectionism is just the reaction, not the cause. Trade is collapsing because people have become reluctant to spend, invest or lend anywhere - especially, far from home.

The guy who invented the shipping container industry works in the office above us, here in the "Sea Container Building" in London. You know, the building with the gold balls on the roof. He's an American from Kentucky who later got into the railroad business and went broke. But after WWII he figured out that shipping could be made much more efficient by putting goods into metal containers and using big cranes to stack them on ships. Thanks to his innovation, globalized trade got a huge boost.

But now, for the first time in its 53-year history, container traffic is going down. In the last four months, not a single new container vessel has been ordered. China - the planet's largest factory - is making, selling and shipping less stuff to the rest of the world. Exports to the United States are down 10% year on year; exports to Europe are down 17%.

In the United States itself: "CEOs see grim economic outlook..."

"Biggest GDP drop since '46..."

"Toll Bros. first quarter revenue down 51%...no end in sight to real estate trouble..."

"Caterpillar to cut 2000 jobs..."

The headlines are nearly unanimous: it's deflation that menaces the world, not inflation. But Sparky Benarnke...and Barack "House-o-fire" Obama...are on the case. They're not going to rest until they get that darned conflagration going.

Eventually, they'll get a small flame started... And then, watch out...it could burn, baby, burn... like a brush fire in Australia.

And that's when the Chinese will really hate us.

*** "Fears of a return to the 1930s are too pessimistic," writes David Bowers in the FT .

Au contraire, they seem too optimistic to us.

In the '30s, the feds still had a residual respect for law and order. So did the public. When the Roosevelt administration went about taking control of the economy, it had to fight against the courts the whole way. As many as 1,600 injunctions were issued to prevent the feds from carrying out their grandiose plan. When these cases got to the Supreme Court, the court threw out key parts of Roosevelt's program as unconstitutional. The U.S. Constitution was meant to limit was government could do. Apart from the express undertakings described in the document, all other things were supposed to be left to the states and to individual citizens. Nowhere in the U.S. Constitution was there any mention of an "industrial recovery" program, for example. So the Supremes threw it out.

Then, Roosevelt attacked the court itself. He argued that "nine old men" should not be allowed to stop progress. He tried to pack the court with more justices ready to do his bidding. This was too much for Congress to swallow; even his vice president was against it. The amendment to increase the number of Supreme Court justices failed.

But then, the old men themselves failed. They died. And as their mortal envelopes got packed in the dirt, new justices were appointed - such as Felix Frankfurter and William O. Douglas - who were willing to go along.

This time there is practically no resistance. President Obama enjoys support, both wide and deep. The public is behind him. Congress is on his side. And the courts have long since given up trying to limit the power of the federal government.

Everyone wants something for nothing. And everyone believes he can get it from the feds. As a result, we're looking at trillion dollar deficits - as far as the eye can see.

That's not all, of course. Back in the '30s, the dollar was still linked to gold. The price was set by law and dollar holders were free to convert their dollars into gold at the statutory price. In order to devalue the dollar, the Roosevelt administration had to call in the nation's gold - making it illegal for private citizens to hold the yellow metal - and then revalue gold upwards. In a stroke of a pen, debts denominated in dollars were clipped 60%.

Now, there's no need even for the pen. Dollars float on a sea of debt...with no golden anchor to windward. All it takes is a whoosh of inflationary breeze and the buck is off! No need for calling in gold. No need for legislation. In a few days, the value of the dollar could be cut in half...or by 75%...or more.

And who's going to protest? The Chinese? Yes...but they don't vote in U.S. elections.

Although the dollar is no longer bound to gold, smart investors still see it as the ultimate store of wealth...and so should you. Hedge your investments against the imminent demise of the dollar by holding onto some gold. It's easier than you think. See here .

Bill Bonner
for The Daily Reckoning Australia

• President Barack Obama and Franklin Roosevelt Are Becoming Akin
• Politics and Investment Intertwined
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Irving Fisher Remains Immensely Important in the History of Economic Thought
• US Economists Think China Should Raise the Value of Yuan

In the few words that follow, we explain why. First, the background:

"The history of the world is but the biography of great men," was Thomas Carlyle's contribution to the genre. But here at The Daily Reckoning we are more of the 'cometh the hour, cometh the man' school of history. When something needs doing...there is always finds some clown dim enough to do it. Osama bin Laden was that man.

"Bleeding America to the point of bankruptcy", was what he was up to, he said in a videotape. He even did the math. "Every dollar spent by al-Qaida in attacking the US has cost Washington $1m (£545,000) in economic fallout and military spending," said the report.

"We, alongside the mujahideen, bled Russia for 10 years, [in Afghanistan] until it went bankrupt... So we are continuing this policy in bleeding America to the point of bankruptcy."

How many generations will still tell of bin Laden's triumph? He brought down not just one empire, but two. His band of terrorists leeched the Soviets so thoroughly, they fainted. It was no coincidence that the Soviets lost Afghanistan in the same year their empire disintegrated. Then, he delivered a challenge to the America's 'amour propre.'

The attack on the World Trade Center incited a death wish. The feds flashed a Red Alert; Americans cowered in their houses and sealed their windows and doors against biological attack. The 9/11 attackers could have been pursued by the usual gendarmes - at negligible cost. Instead, in the general panic, the Bush administration decided to go all out. Thus it was that the greatest stimulus package since WWII began - in haste and in delusion.

The federal budget went from its biggest surpluses to its biggest deficits. Interest rates were cut too - to an emergency rate of 1%. Within 24 months, the bubble in the Nasdaq was replaced by much bigger bubbles - in housing, finance, derivative debt, art, private equity, executive compensation, student loans and other forms of private debt. In effect, bin Laden suckered the fattest man on earth into having another éclair. The thunder coming from the financial markets for the past 18 months is the noise of his midriff exploding.

But we are not writing to complain about Osama bin Laden or the Bush Administration's reaction. When it comes to war and adultery, make-believe may be better than the real thing. Certainly, it is safer. In the War on Terror, the enemy had no tanks...no aircraft... no ships...no armies...no celebrated strategists...no famous generals...no sophisticated weapons...no military culture...no leather trench coats...no burnished helmets...no battle cries.... The problem was, it was hard to find the enemy at all. The Department of Homeland Security conducted 3 billion airport inspections looking for them. We remember getting patted down so thoroughly we felt we should leave a tip. But how many enemy combatants do you think they nabbed? Not a one.

There are two possibilities. The first is that the security procedures were so fearsome that terrorists dared not try anything funny. The second is that there weren't really many terrorists at large - at least, not in the United States of America.

But compare it to WWI or WWII...or even a penny ante affair like the Spanish American war. The War on Terror mobilized the whole nation in a Great National Cause...at much expense, much damage to the Constitution, and much inconvenience, but without actually causing much real suffering. Sure, a few hapless Muslims, caught in the wrong place at the wrong time, were put on the rack. And yes, the cops in London gunned down a Brazilian electrician. Back in the United States, young couples did not embrace as they had in WWII - that is, as if there would be no tomorrow. Instead, they spent money as if there would be no tomorrow! No doubt, the desperate spending contributed to the bankruptcy of the whole system of bubble finance. But compared to the pain of a shooting war; the War on Terror was a delight. As far as we know, the Department of Homeland Security suffered not a single casualty. Not even any self-inflicted wounds. No executions for treason. And hardly any reported cas es, neither of fleeing in the face of the enemy...nor collaborating...nor sabotage.

What a shame to let such a marvelous war to end without even a victory parade. Some of the agents should at least get medals for courage under fire...or exceptional valor.

Perhaps some special award Such as the special agents who arrested Tamera Jo Freeman. A 'Black Heart' medal might be appropriate. The woman was on a flight to Denver when her children got into a squabble. She spanked them both...and then Homeland Security agents put the cuffs on her. Charged with committing an "act of terrorism" she spent three months in jail and lost custody of her children.

And there ought to be some medal for the Pentagon flatfoot who put the long arm of American law all the way across the Atlantic and onto the shoulder of Gary McKinnon. Mr. McKinnon, as the mayor of London informed us on Tuesday, believes in UFOs. And to prove that the U.S. army is hiding information on extraterrestrials, he hacked into the Pentagon's computer...leaving his email address and a message: "Your security is crap."

Rather than thank him for this useful observation, the Defense Department no doubt put out a billion dollar consulting contract for someone to tell them their security is crap...and put out a warrant for Mr. McKinnon's arrest on a terrorism charge. That kind of service above and beyond the call of duty should be recognized.

So form up the battalions of veterans! Assemble the legions of luggage inspectors and metal detector operators...and all the thousands of investigators, worn down by five years of following leads to nowhere! Dress them up in bright, clean uniforms...and give them their moment of glory. Pin medals on their chests. Then have a jolly march down Fifth Avenue. Line the streets. Give them a hearty hoorah as they march by. Throw out the ticker tape. Young girls...fling yourselves at them...and get a kiss! And then, send them home.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning Australia

• The War on Terror Has Morphed Al-Qaeda Into a More Formidable Enemy
• Sicking “The Fuzz” on Terrorism
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• “I” is Lonely…
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Personally, this was surprising, since I didn't know how or why bankers would know what the wealthy are doing, especially as concerns gold, but maybe this is because my relationships with my bankers are always frosty for one reason or another, usually centered around my failure to maintain a minimum balance in my checking account and then getting loud and angry when they hit me with a service fee as a result.

Naturally, I go down there and make a big fuss until they agree to wipe the fee away, and every month it's the same thing, over and over, and so I am asking, "Why in the hell don't you just stop assessing me the fee and save us both a lot of trouble, you moron?" and they are saying, "Because you agreed to pay them when you signed the account application, you Cheap Mogambo Bastard (CMB)!" but now I am supposed to tell these greedy halfwits that I am buying gold? Hahahaha!

Naturally, one would start to look for an explanation for this "gold seeking" behavior, and soon they provide one, in that gold "is the ultimate crisis bet, that when the world is falling apart, gold will retain its value."

And the world will certainly fall apart, just as my world always falls apart after long spells of excesses and heedless hedonism, although the world's problems will probably not be caused by somebody getting pregnant or demanding that I pay a huge bar tab, but by the horror of inflation.

And sure enough, inflation is coming, as it was not that long ago that the loathsome chairman of the Federal Reserve, Ben Bernanke, was saying that insane excesses of monetary stimulus were not going to be enough!

And he was proven right, as even though he has driven interest rates to literally zero in proving it, and now, he says, Congress has to fire up some of that insane fiscal crap of deficit-spending and tax policy changes to make it all work out, because now the news is even worse and he realizes that not even more insane Federal Reserve monetary policy of creating more money and credit can cure the bankrupting maladies caused by previous decades of insane monetary policy, especially since 1997 when that bastard Alan Greenspan, then the chairman of the Fed, really lost his freaking mind.

Specifically, Bloomberg.com reports that "Federal Reserve Chairman Ben S. Bernanke warned that a fiscal stimulus won't be enough to spur an economic recovery and that the government may need to buy or guarantee banks' tainted assets to revive growth", which Bill Bonner here at The Daily Reckoning cleverly sums up as "buying trash and paying cash."

In other words, take your worthless assets to the government, who will bail you out by paying you more than the assets are worth! Hahaha!

Of course, there was the usual crapola like the incomprehensible "Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," which is what Bernanke is reported to have said in a speech at the London School of Economics.

One would have expected somebody in the audience to say, "What? The Mogambo is right when he called it incomprehensible! What in the hell is that supposed to mean, you stupid Yank blighter?"

He did not explain it, but instead went on to utter the equally incomprehensible "More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets." Hahahaha!

The end result is that it looks like there is going to be a lot of borrowing and printing of money, as Bloomberg.com reported that "The U.S. budget deficit soared to a record in the first quarter of the 2009 fiscal year," as the deficit jumped to $485.2 billion", which was so much that it is "surpassing the shortfall for all of last year", when " the shortfall was $454.8 billion."

As scary as this is, the numbers are a Big Stinking Load Of Hooey (BSLOH) because it is much worse than that, as I can easily prove by showing that the national debt right now, in January 2009, is $10,635 billion, whereas last year at this exact time it was only $9,210 billion, a difference of a sizzling $1,435 billion! A trillion and a half dollars more debt in twelve months, yet these guys say that it is only $454.8 billion!

The word "Gaaaahhh!" escapes my throat, as all of this was BEFORE all the new promises of massive new deficit spending! Trillions of dollars of federal deficit spending per year, for years and years and years into the future! Again, "Gaaaahhh!" We're freaking doomed!

An admonition for you to frantically buy gold would usually ensue right about here, but I am too freaked out to even think about it, as proved by the sheer number of times I said "Gaaaahhh!"

Until next time,

The Mogambo Guru

for The Daily Reckoning Australia

• A Government of Spendaholics
• Paul Krugman Advised the Bank of Japan to Purposely Cause Inflation
• Roasting G-20 Weenies on a Golden Spit
• Federal Government Making Taxpayers Pay Taxes for Nothing
• The Destruction of the Dollar by the Federal Reserve