'We didn't ask you to stock up all those dollars,' as Obama might have put it. 'It's not our fault if the dollar goes down and you lose money.'

Perhaps Mr. Obama should have quoted the immortal words of a former US Secretary of the Treasury, John Connolly. "It may be our dollar, but it's your problem."

Over at USA Today, the editors are more concerned about human rights. The paper must imagine itself back in the days of Woodrow Wilson or George W. Bush, when the US nobly embarked on a mission to raise all of mankind out of sin and error. In effect, Mr. Obama said that all people have 'universal rights,' including the right to a free press. China figured this was just the sort of opinion that its people didn't need to hear. So, it killed the story in its own press. The American president might as well have been talking to himself.

China is today's big story. Throughout the world's media there is much buzz and blather about the "romance"...the "historic relationship"...between the two titans. Some reporters see love. Some see jealousy. Some see rivalry.

Here at The Daily Reckoning we are suckers for romance. Give us some "a cigarette that bears a lipstick's traces...an airline ticket to romantic places..." and we are moonstruck. But we don't see much romance in the US and China hook up. What we see is the sort of things that delight psychologists and bore everyone else - perversion, co- dependency, and enabling.

On the surface, the two giants bicker over money like any other couple. The US accuses China of being a tightwad...holding its currency down and saving too much. China accuses the US of being a spendthrift, destroying its own purchasing power by wanton and reckless expenditures.

"US president's currency call breaks with script," says a headline in The Financial Times today. US economists think China should raise the value of the yuan. This would immediately lower the value, domestically, of the trillion(s?) worth of US-dollar assets China holds as reserves. It would also make Chinese products less competitive on the world market.

Mr. Obama wasn't supposed to say anything about it on his trip. It would be like bringing up your husband's drinking problem on your wedding anniversary; it would spoil the occasion.

Apparently, Obama couldn't help himself. Or maybe he just thought the folks back home would like to hear him give the Chinese a piece of his mind.

But how does the American president know what price to put on the yuan? A sinking dollar is good for the goose over in the US. Why isn't it okay for the gander in the Middle Kingdom?

A strong yuan would help the world economy "rebalance," say economists who think they know what they are talking about. In a nutshell, the Chinese produce too much; Americans consume too much. A higher yuan would come down on the high side of the scale - giving the Chinese more purchasing power (thus increasing consumption in the Peoples' Republic)...and making Chinese exports more expensive (thus decreasing consumption across the Pacific). With a stronger yuan, the Anglo-Saxon economies would be able to produce and sell more things to the Chinese...thus tilting the US economy more towards capital formation and production.

Chinese authorities are no dopes. They know they have a "floating" population of some 150,000 million people who are looking for work. They know that if they don't find some way to keep these people occupied they are likely to cause trouble. Trouble is the thing China's leaders most don't want.

"You think you've got trouble," Premier Hu Jintao might have replied to Mr. Obama. "Did you know that there are something like 200 million Chinese who still get by on as little as a dollar a day? Let's face facts. You're sitting there in Washington, comfortably talking about how much free health care and unemployment benefits to give the American people. We don't have the time...or the money for those kinds of things. Too many Chinese people. They don't earn enough to afford the kind of cradle-to-grave bribes you give your people. We have to keep them working; there's no other way.

"Besides, we don't quite see why we should pay for your mistakes. It wasn't our economy that blew up. It wasn't our financial industry that sold houses to people who couldn't afford them. It wasn't our consumers who spent more than they had and went too deeply into debt.

"It's the debtor who's supposed to pay, not the lender. We're the lender!"

Behind all the superficial arguing, accusing and kvetching, however, is a sick relationship. It has give and take. But the US is all take. China is all give. And now, on both sides, public authorities make the same mistake. In the US, they try desperately to prod Americans to take more...to continue doing what they were doing wrong. They offer incentives of every sort to lure consumers to consume even more. And their solution to the debt overhang is to hang on even more debt.

In China, meanwhile, the authorities desperately prod their people to give more...to produce more. Or, at least to build more plant and equipment with which to turn out more goods.

In the US, consumer spending is about 70% of the economy. In China, fixed capital formation is estimated to have made up 70% of China's growth in 2008 and as much as 90% in the first half of this year.

Is this a formula for a happy marriage? Over the last two years, this co-dependent relationship has broken down. Paul Krugman wrote in The New York Times that we've seen "the greatest collapse in world trade in history."

But neither side has learned a thing. The taker now proposes to take more. The giver now proposes to give more.

They don't need counseling. They need a divorce.

Bill Bonner
for The Daily Reckoning Australia

• Chinese Yuan Marches Towards World Domination
• Admonishment from China and the Decline of U.S. Credibility
• US Has Highest Unemployment Rate of All Major Economies
• Chinese Consumers Are Getting Shiny New Credit Cards
• Geithner Reassures China that America Takes Financial Obligations Seriously

And today we take up a foul and disagreeable task. We ask ourselves: what if we are wrong?

If you bought gold when we first recommended it, ten years ago, you are in a very comfortable position. Gold sells for more than 4 times as much today. But what should you do now? And what if you didn't go for broke on gold in the early '00s? Is it too late to get in on the bull market?

To give you a warning, in the following windy ambulation we come to no conclusion we haven't come to before. We say gold is going to the moon. If we are wrong about when...we will be delighted sooner than expected...self-satisfied...and insufferable for years. If we are right, we may have to wait a long time before saying "I told you so."

First, the press has certainly noticed the bull market in gold. How could it not? Most reporters say gold is going up simply because the dollar is going down. In the popular press, we found no other explanation. In fact, much of the notice of gold seems to occur within articles about the dollar. We found, for example, that the dollar is at a 15 month low...and, coincidentally, gold has just hit an all-time high.

There's something lopsided about this account of things. If the yellow metal has hit a record high, how come the dollar is down for only 15 months and not since the Flood? Makes you wonder if the dollar isn't the whole story.

Elsewhere, we find that the dollar is trading at $1.49 per euro. Wait a minute. We remember the dollar at the exact same level...was it a year ago...more...? And it's been at that same level, more or less, all the while gold has gone up more than 10%.

It's not the fall of the dollar that is driving the gold market, in other words, it's something else...it's the fall of ALL paper currencies. For when the dollar goes down, so do the rest of them - more or less. No nation wants its currency to rise too much against the greenback. Americans are still the world's biggest spenders. They spend dollars...not rubles...not euros...not zloties. A nation whose currency rises against the dollar is in a competitively weaker position. Its costs - in local currency - go up while its sales - in dollars - go down (it has to charge higher prices). Typically, central banks buy up dollars with money created for that purpose...thus increasing their own money supply and thus decreasing the value of their own local currencies relative to the dollar.

Since all the world's central banks, more or less, are doing this, all paper currencies are going down together - compared to gold.

But wait, wouldn't they be going down together against everything else too? If currencies are getting weaker...shouldn't they be getting weaker against oil...and McDonalds' hamburgers...and woolen underwear? The oil price is at $78 - where it's been stuck for a while. Oil is a special case, but almost all consumer prices are stuck too. Take out energy and food, and consumer prices are deflating in the US. Put back in the energy and food and they're just stuck. There is no sign of generalized consumer inflation - not in the USA and not in Europe either.

The only thing that is going up is gold. There is a bull market in gold and gold alone. But why?

According to the law of supply and demand, you expect the price of a thing to fall when its supply increases faster than the demand for it. In today's news are two reports on gold production. One, from South Africa, tells that a scientist says the nation's residual gold in-the- ground is much less than expected. It has been overstated by 900%, he says. Another report shows the output of from the gold mining industry clearly topping out. Gold supply, in other words, is increasing, but not as fast as it used to.

The supply of paper money, on the other hand, needs no new discoveries. Since there have been huge increases in the monetary base of paper money all over the world, it is reasonable to expect the price of paper money to go down. Gold, traditionally the thing that paper money is priced in, should go up. Speculators are buying it now in anticipation. Even central banks are buying again. And nearly everyone expects the price to continue going up.

As near as we can tell, gold is properly priced already. Comparisons are rough, but an ounce of it appears to buy about as much stuff as it did 2,000 years ago. You can buy a suit of clothes for an ounce of gold - no problem. Go to Wal-Mart; you can buy 4 suits.

As Roy W. Jastram wrote in his 1977 book, The Golden Constant, gold's "price has been remarkably similar for centuries at a time. Its purchasing power in the middle of the twentieth century was very nearly the same as in the midst of the seventeenth century."

Gold...or the people who speculate in it...may be looking ahead. Or, they are dreaming. If gold is already about where it should be why would you pay more? You must expect paper currencies to go down...to buy less stuff. In other words, you'd have to be anticipating a fall- off in the value of the paper currency.

It may come to pass exactly as they imagine it. Gold may rise and rise and rise...as paper currencies fall and fall and fall some more. In that case, we here at The Daily Reckoning headquarters as well as all of our dear readers who followed our advice 10 years ago will be delighted. Gold may hit $1,500 by the end of the year. By the end of next year it may be $3,000. By the year after, well...who knows...? "We told you so," we will say.

But there is almost always more under Heaven than speculators think. When we look into it, we see gaudy increases in the monetary base...but only very modest increases in M2, the money that buys stuff. What's more the rate of increase for M2 has fallen in half over the last 8 months. It's now only about 7% annually in the US. And when we look at the CPI we see no increase at all. And despite the 'recovery,' unemployment is still rising and house prices are still falling. So, if speculators see the price of stuff going up in paper currency terms, they must be looking way over our heads.

To more fully describe our own state of mind, we don't doubt that all the liquidity added to the world's monetary system will eventually be soaked up by paper currencies. But it could take a long time; we might be dead before it actually happens.

But since we are entertaining the possibility that we might be wrong; let us look at what is going on in more detail. If there were a real recovery - as announced in the world's newspapers and proclaimed by its stock markets - you'd expect a rising increase in demand...leading to higher prices...leading to a higher gold price.

Yesterday's news brought word of greater retail spending than anticipated. This was greeted as more evidence that a recovery is actually underway. But upon examination, we discover that the evidence comes almost all from auto sales. We also find that the number crunchers contributed to the lift by revising figures for September. These are month to month movement numbers. So you can raise October's number simply by lowering the number for September.

What's more, while sales went up...auto prices actually went down - in paper dollar terms. This doesn't sound inflationary to us.

Meanwhile, news reports said that fewer people are defaulting on credit card debt. The reports also tell us that delinquencies on credit card debt are up. So, we'd have to call that a draw.

And then there's the news from GM. The giant, government-owned auto company says it will repay its loans from the feds earlier than expected. But wait...we also find that the company continues to lose money. How then will it repay debt? Perhaps by refinancing!

Other reports are similarly confusing and inconclusive. Profits are up on Wall Street. But wait...sales are down. You can increase profits by cutting expenses (getting rid of employees, mainly). But you can't increase sales. And as long as sales are falling you have to expect lower profits in the future. (Stock market buyers...take note.)

Our colleagues over at The 5-Min. Forecast sent through this chart, illustrating the "recovery that wasn't."

"With the majority of publicly traded companies done reporting third quarter earnings," writes 5 editor, Ian Mathias, "the trend is clear: Profits were way better than expected, revenue was flat at best.

"Of what little we recall from freshman year, Finance 101 insists that profit equals revenue minus costs. Thus there really can't be any questions left as to how the market pulled off this quarter...companies are simply trimming the fat at an incredible clip. Not exactly a long- term plan for growth."

The New York Times reports that job losses continue to be "deep and enduring." Mortgage applications are running lower than they were 9 years ago. "More households report food shortages," says a Wall Street Journal headline. And insiders are still selling their own companies.

So, it still looks to us as if we are in a depression...one that will take many years to sort out. It is unlikely that the bull market in gold will reach its final blow-off top while the depression continues. But stranger things have happened. Eventually, gold will reach the apogee of its bull market. And when it does, we want to be ready for it. We will celebrate with champagne and sparklers.

Still, we wouldn't get out the party hats...not just yet.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Gold is in a Bull Market
• We are Confident the Bull Market in Gold is Not Over
• Investors to Drive Next Leg of Bull Market in Gold
• What Happens to Gold When High Inflation, Excess Cash, and Falling Dollar Jolts Economy?
• A Gold Standard, Without Gold

"Why don't you move back into your own house," his father wanted to know.

"Dad, I've got a good tenant in there. Besides, it's not in very good shape. I'd rather sell it than invest more money in it. And there are so many places on the market, I can rent something better. Even after a big drop in prices it is still cheaper to rent than it is to buy something."

There are probably millions of homeowners who would like to sell - if they could. This hidden inventory of unsold houses will depress housing prices for a long time.

But there's a crisis coming in commercial real estate too.

"An extreme amount of commercial debt is to mature over the coming years," writes real estate investor George Karahalios in Marc Faber's Gloom, Doom and Boom Report. "And unlike the residential market, there is no safety net (Fannie Mae) for commercial loans. Instead investors must rely on financing through commercial banks, a few insurance companies, and other private lenders who now demand much higher interest rates and more equity for the risk associated with these investments. Thus, not even the Fed's printing presses can save commercial property prices, and I am expecting certain locations to crash, perhaps falling as much as 50-80% from the peak."

So you see, dear reader, there is bad news ahead - a lot of it. Stocks will go down. Gold will go down too - most likely - when people realize that the economy faces a long, deflationary depression...not a period of inflationary growth.

But while stocks are fair weather friends, gold sticks by you in foul weather too. Right now, gold is rising on good news. Eventually, it will soar when the news turns bad. (Though...not necessarily right away...)

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Housing Slump Has Fattened the Inventory of Unsold Homes
• Commercial Real Estate May Be the Next to Fall
• Trends Make Investors Less Afraid of Risk
• Ireland Going Through Same De-leveraging Process as the US
• Housing Prices Follow GDP Growth and Inflation

But along came two very important bits of information.

First, we got word that the crisis was officially over. GDP grew last quarter. Thanks to all the Cash for Clunkers, Cash for Bankers, Cash for Houses, Cash for Trash, and cash for every other blessed thing under heaven, the number crunchers were able to report positive economic growth for the third quarter.

Let's not get too excited. Stocks bounce. Bonds bounce. An economy bounces. Even dead economists bounce. And if we're following the Japanese experience, with a long, slow on-again/off-again period of depression, we can expect some quarters of growth, followed by quarters of non-growth. It's going to be a painful adjustment to the 'new normal,' whatever that is.

The other important bit of news was that the Fed - faced with undeniable evidence of growth and prosperity - decided to err on the side of caution. It will keep monetary policy loose from here until kingdom come, if necessary, in order to avoid a Japan-style slump.

But so far, a Japan-style slump is just what we seem to have...and our public officials are fighting it, Japan-style.

Unemployment is headed up. The U6 figure - a more accurate picture of how many people are out of work - is up to 17%. There are 1.5 million homeless children in the US now, including 300,000 in the state of California alone. One out of 10 Americans will not bite the hand of government - for it is the hand that gives him his food stamps.

Foreign direct investment has dropped 30%. International trade is down 10%.

Do you call this a recovery? We don't.

As David Rosenberg puts it, the man on the street is perhaps "less enthused by the fact that a lower rate of inventory de-stocking is arithmetically underpinning GDP growth at this time."

In other words, it's 'growth' that only an economist could love...and then, only an economist who was an idiot. Rosenberg:

"Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go - and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

"Only 29% of those polled believe the economy has hit bottom - imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally - not the onset of a new bull market) has not swayed their view (or ours for that matter). There is going to be some very tough slogging ahead as far as the economy is concerned."

Growth is largely illusional. It is the result of delusional policy- making at the Fed.

So, we'll just keep our Crash Alert flag flying.

Bill Bonner
for The Daily Reckoning Australia

• Markets Rise While the Economy Sinks
• Take Away Stimulus Spending and You’ve Got an Economy Entering Depression
• Bear Market Bounce a Sure Thing
• AIG to Receive $85 Billion Loan from Fed
• Feds Have Used the Correction to Increase Their Power and Add to Their Wealth

Last week, stocks went up. Stocks went down. Not much was proved one way or another. The week ended in a draw, as near as we can tell.

But we think we are making progress in understanding what is going on. The private sector is de-leveraging. Now, it's the public sector doing the heavy lifting. It is leveraging everything it can.

Leverage in the private sector led to the banking crisis/bear market of 2007-2009. Debt always leads to trouble. Next up: a crisis in the public sector.

But wait...hold on...not so fast...we haven't reached the end of the private sector crisis yet! Bank lending is still falling. House prices are still falling. Unemployment is still falling. Soon, stock prices will be falling again too...

First, let's see what's in the headlines. Last week there was a lot of press about the pay czar and his efforts to limit compensation in the companies that the feds bailed out. The public and the news media love this sort of thing. It's a battle between the greedy rich and the public interest, or so they believe. The public hates bankers. But they don't want to see just pay capping; they want to see knee-capping. We'd like to see it too. Or maybe public flogging. Or at least a lapidation or two.

But our true sympathies are with the greedy CEOs. After all, they stole the money fair and square. They should be allowed to keep it. The feds wanted to leverage up the financial sector by giving money to the banks. What'd they expect? The bankers took it.

Yes, the financiers are paid outrageous amounts of money - far beyond anything they are worth. In fact, if you studied it carefully, you'd probably discover that their net contribution to the betterment of mankind is now negative.

The bankers are betting that the money they were given by the feds will be worth less next year than it is this year. So they exchange it for everything and anything, confident that when it comes time to pay it back it will be even easier to come by than it is now.

So far the bet has gone their way. Copper has doubled. Gold is up 20%. Stocks markets all over the world are up 60%. Foreign currencies, too, have beaten the dollar.

Will the wager against the dollar continue to pay off? Well, that's the big question. If so, you should stay in stocks, gold and commodities. If not, you should move to cash.

But it hardly matters to the gamblers. They're playing with someone else's money! If the bets go well, they pay themselves huge bonuses. If they go badly...well...hey...gimme a bailout!

In the long run, bets against the dollar are almost sure to turn out okay. All paper currencies go to zero, eventually. But in the short run, who knows? The whole world is betting against the greenback. With such a massive short position against the buck, it would be just like Mr. Market - aka Mr. Mischief- maker -- to send the dollar up.

But you can't blame the bankers. They're performing a very valuable service. They are helping to separate fools from their money. Too bad we taxpayers are the fools....

Among all the whiners and kvetchers about bankers' huge bonuses hardly a single one draws the obvious conclusion:

That them that deserve to go bust should be allowed to do so.

"I remain of the view," writes Martin Wolf, a bit pompously, in The Financial Times, "that the only thing worse than rescuing the system would have been not rescuing it."

He's welcome to his opinions. And if he used his own money to bail out the bankers we would have no objection. In that case, it would just be a futile and foolish act. Instead, he insists upon using our money...which raises the charge from stupidity to larceny.

Another message that came through last week was that the real economy is not improving. Good news came in from several quarters. But the news that really counts - housing prices and jobs - was bad.

"It's all bad. That's all we know," said John Stepek, editor of MoneyWeek. "People ask if we're going to have inflation or deflation. The bulls think we're going to have inflation. The bears bet on deflation. But I'm not sure it matters. We're probably going to have both.

"The point is, whichever we have, it's going to be the bad sort. Neither inflation nor deflation is necessarily bad. Prices have to adjust. That's how the market conveys its signals. When prices rise, it tells producers to get busy and increase output. When prices fall, it tells them to lay off. In the natural order of things prices usually fall. Or, they should fall. This is 'good' deflation. It just means that producers are becoming more efficient, as they should. There's good inflation too - when prices rise due to increased real demand. When people earn more money, they can buy more things; prices rise.

"But what we're going to see is bad. Bad inflation. And bad deflation. It is the result of monetary problems and mismanagement. And it is going to send all the wrong signals and inevitably make things worse. First, the deflation is bad because it is result of a massive de- leveraging accompanied by a write-down of debt and assets. It's a depression. Or a major recession. Or a 'great contraction.' Call it what you will. It's a deflation in which prices fall...and it's not going to be any fun.

"Then, there's most likely going to be bad inflation too - caused by the central banks printing too much money. This is bad inflation because it is just an increase in the quantity of paper money, not an increase in real demand.

"We don't know exactly what is coming. But whatever it is, it will be bad."

Another big item in last week's financial press was the "Cash for Houses" scheme. The feds give new house buyers an $8,000 tax credit. But since not all new buyers buy because of the credit, the actual cost to the government per additional new house purchased is much higher than 8 grand. For each additional house purchased because the credit taxpayers are paying as much as a quarter of the entire cost of the house.

And now there is a proposal to extend and broaden the credit. Soon it may be "Cash for Everything."

This sounds crazy, but there are a lot of economists who think more stimulus is necessary. Nobel prize winner Paul Krugman, for example. And Richard Koo, mentioned here last week. They've seen what happened in Japan. And they see that the real economy is not recovering as they hoped it would. Now, they warn that America might have a "Lost Decade" if it doesn't continue to stimulate the economy.

How long must it continue bailing out and stimulating? Until consumers have finished de-leveraging, they say. How long will that take? Maybe another 5 years, by our calculation...maybe much longer.

But wait...the whole problem is too much debt, right?

Yep.

But the only way the government can stimulate is by going further into debt, right?

Yep.

And isn't the budget deficit already at $1.6 trillion...or 11% of GDP...the most it has been since WWII?

Yep.

Well, then where's the benefit? Won't the public sector have to de- leverage too?

Bingo!

How does the public sector deleverage?

Two possible ways - honestly...and dishonestly. It can pay down its debts to a level at which they can be carried even if interest rates go up sharply. They did it after the War Between the States...after WWII...and even during the Clinton years. Believe it or not, when the Congressional Budget Office looked ahead in 2001, it saw a budget SURPLUS for 2008 of more than $600 billion. Surpluses had been coming in for years during the Clinton administration. They thought it would keep going like that. Instead, 2008 saw a DEFICIT of nearly $500 billion.

The higher the debt and deficits go the harder it is to pay them down honestly. Eventually, the feds reach the point of no return...like a guy who's so deep in debt he can't possibly work his way out. Then, you get another crisis...either in the form of default...or (hyper) inflation...or both.

Tomorrow, we're off on the road to the Andean highlands...

No phone. No internet. No fax. No Blackberry. No iPhone.

We've got cows to round-up, wrestle, and vaccinate.

In the meantime, we'll leave our "Crash Alert" flag flying...and send a message as soon as we can...

Until then,

Bill Bonner
for The Daily Reckoning Australia

• Bankers Take Money From the Government and Use it to Speculate
• The More Money in a Financial System the Less Each Unit is Worth
• Warren Buffett: People Do Not Make Money by Betting Against the US Economy
• The Feds Are Trying to Avoid Deflation
• The Battle Between the Forces of Inflation and Deflation Wages On

But a warning about what? Sure, stocks, oil, and gold were all down yesterday and the U.S. dollar was up. But is it really the end of the dollar carry trade? And if it is, what happens next?

More cow bell!

We should back up a second. What is the dollar carry trade? It's the engine of bank profit growth this year. It's what's given the illusion that the financial system has recovered from its brush with death last year.

But as you'll learn today, the bankers, the Fed, the media...the whole lot of them...have learned nothing from last year. The hangover was just beginning to set in, so everyone began drinking again heavily. And now the party is wild and out of control. Even the cops are drunk.

Incidentally, this complete abandonment of monetary sobriety and fiscal prudence shows up every day in real life, where the declining value of money is paralleled by a general decline in public behaviour. For example, on Sunday morning we were tucking into a breakfast of banana caramel pancakes (with a scoop of vanilla ice cream on the top) when three incredibly drunk but fairly well dressed middle aged men had a seat next to us at the cafe.

They wanted to chat about the John Birmingham book on the table. They wanted to smoke. They wanted to laugh, and did so loudly to the point where they began upsetting the various dogs assembled in the sun. They ordered a pitcher of beer. They were served. It was 9am and they hadn't been to sleep.

Our cow bell tells us that the financial party thrown by Ben Bernanke may soon be ending. The dollar carry trade, by the way, is where financial firms and speculators borrow cheap money in the U.S. and use it to buy higher yielding assets elsewhere (like the Aussie dollar).

The carry trade is a bubble enabler and balance sheet stabiliser in the short-term. The Fed keeps rates low, the banks borrow and then buy U.S. bonds (which helps the U.S. fund its deficit), buy stocks, and buy commodities. The dollar carry has fuelled the world-wide rally more so than any phantom recovery in the real economy, where employment hasn't recovered and wage growth is hard to find.

What the carry trade has not done is fundamentally improved the balance sheets of the very financial firms that were at risk of insolvency last year. Why not? First, the earnings rebound in the first three months of the year was not driven by better business conditions. Speaking to the Financial Times earlier this week, George Soros said, "Those earnings are not the achievement of risk-takers...These are gifts, hidden gifts, from the government."

The banks booked profits from trading stocks and bonds. And because the Fed, through quantitative easing, was supporting bond prices directly, it was as close to free money/a rigged market as you can get. With enough leverage, even small gains in bond prices were bankable.

But now there is an enormous, gut busting irony to the position the banks find themselves in. Remember that the original idea to repair bank balance sheets and restore their capital positions to healthier levels was to replace toxic mortgage-backed debt with safe, sound, and liquid U.S. Treasuries. Snort. Guffaw.

The irony is that those same Treasuries could be the next big blow up, wiping out the banks thin equity capital sliver all over again, and plunging the financial sector into a second wracking round of forced deleveraging and asset sales. Round two of the recession, morphing into a Depression as the public sector ramps up deficit spending to make up for the collapse in household and business spending.

We all know how much serious the cycle of deleveraging and asset sales was last time around, so it's not a claim we'd make lightly, or without some evidence. So let's get to the evidence. First is an article from Gillian Tett, also in yesterday's FT, titled "Rally fuelled by cheap money brings a sense of foreboding."

"Earlier this month," she begins, "I received a sobering e-mail from a senior, recently-retired banker. This particular man, a veteran of the credit world, had just chatted with ex-colleagues who are still in the markets - and was feeling deeply shocked."

" 'Forget about the events of the past 12 months ... the punters are back punting as aggressively as ever,' he wrote. 'Highly leveraged short-term trades are back in vogue as players ... jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds.'"

" 'Oh, I am sure the banks' public relations people will talk about the subdued atmosphere in banking, but don't you believe it,' he continued bitterly, noting that when money is virtually free - or, at least, at 0.5 per cent - traders feel stupid if they don't leverage up.

" 'Any sense of control is being chucked out of the window. After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months,' he added. He finished with a despairing question: 'Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?'"

This 'latest bubble' is in evidence across all asset markets-bonds, stocks, commodities, property, and cash. Free money does not discriminate on the basis of asset class. But nowhere has the bubble been more generous than in the U.S. Treasury bond market. Short-term U.S. bond yields are vanishingly low. The Fed just purchased $14 billion more in mortgage-backed securities last week and now holds $776 billion in MBS and $773 billion in Treasuries. All up, the Fed's balance sheet is at $2.1 trillion.

But here is the thing: the Fed says it's ready to end its program of buying Treasuries and MBS. It realises it will have its hands full funding big U.S. deficits. But if the Fed withdraws its support for bond prices...you can expect bond prices to fall and yields to rise. This may happen even if the Fed keeps buying bonds...but creditors like the Chinese and Japanese stop (as they have done with agency securities.)

All sorts of interesting things begin to happen now, if by interesting you mean terrible but fascinating. Falling bond prices and rising yields would make perfect sense in a U.S. dollar rally. And a U.S. dollar rally makes perfect sense if the carry trade ends and the dollar shorts cover. Speculators take profits in oil, gold, stocks and jump back into cash and the greenback. This is roughly what happened last time the wheel's came off the financial system.

Where does that leave banks and their massive new hoards of U.S. Treasury bonds? An article called "Bank Insolvency Is Not A Dead Issue" by Daniel Aaronson and Lee Markowitz shows that banks have dramatically increased their holdings of U.S. Treasury securities. When you add their existing exposure to U.S. real estate (facing an Option-ARM crisis over the next twelve months) you have a huge swathe of bank collateral that could face another massive write down.

What do you think that might do the global economy? Aside from putting a few more banks out of business, it would again cut off the flow of credit to small businesses and the rest of the economy. It might again cut off the flow of bank credit from international lenders to the Big Four here in Australia. And this time, what kind of aid can the Feds really offer when their last attempt at help (exchanging Treasuries for RMBS) set the banks up for precisely the implosion they were trying to avoid?

As you can see from the chart above, banks have grown assets again with the Fed's borrowed money. You know have a freshly steaming pile of recovering asset prices supported by a thin wafer of equity capital. It's a fraud with a cherry on top. As the charts below, U.S. banks own nearly $1.5 trillion in government securities. And they are gobbling them up like there is no tomorrow.

There is always a tomorrow. But corporations and institutions live and die just like species. Only the earth abideth forever.

We reckon that the entire financial industry is still dangerously close to a species-destroying event. It's leveraged model of asset growth and debt accumulation imploded last year. But the Fed has brought it back, and like a Zombie/Frankenstein mash-up, it's here to torment us all again.

Soros told the FT this sequence of events is causing a lack of confidence in governments. "There is a general lack of confidence in currencies and a move away from currencies into real assets," he told the FT. "There is a push in gold, there's strength in oil and that is a flight from currencies."

So in the short-term, don't be surprised to see a stronger rally in the USD, which would take some of the starch out of oil and gold prices. As the dollar carry trade unwinds a bit, stock markets will fall and so will other asset classes that have zoomed up on the speculation.

But the bigger story playing out is this: the entire method by which the fiscal welfare state funds itself is blowing up. More on how this will happen and what it means tomorrow. Until then, we hope you heard the cow bell.

Dan Denning
for The Daily Reckoning Australia

• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• Fed Announced it Would Buy up to $300 Billion in Treasury Bonds
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position
• The Only Thing Really Going Down Right Now is the U.S. Dollar

But wait...what's this? The average maturity of that debt has come down from more than 5 years to only 4. And according to the Office of management and Budget, if the US continues on its present course, net interest will rise to 5% of GDP in 2019 and 10% in 2034.

And that assumes there is no big increase in interest rates...and that the economy recovers as planned. If either of those things fails to happen, the situation will degrade fast.

Imagine if the government were forced to refinance debt at double-digit interest rates - as it was in the late '70s. Net interest could go to 5% of GDP within months.

We're in a depression, not a recession. Depressions take longer to sort out. But they are also far more treacherous. Because there are always periods when things seem to be going "back to normal," only to go back down again as soon as investors turn bullish.

Richard Koo, author of The Balance Sheet Recovery, recalls how it was during Japan's long, dark passage:

"We had these false starts... The economy would begin to improve and then we'd say 'oh my god, the budget deficit is too large.' Then we'd cut fiscal stimulus and collapse again. We went through this zigzag for 15 years."

Koo understands what is going on, more or less. Companies and households are paying off debt. He and Paul Krugman believe the feds have to continue pumping money into the system or they're going to have a "lost decade," just like the Japanese.

You have to keep the stimulus money flowing "until the private sector de-leveraging is over," he says.

By our calculations, it will take 5-10 years for the private sector to de-leverage. By that time, the feds will have added trillions in debt to public finances. Since they can't finance that much from private domestic savings, and since foreigners will be wary about lending that much even if they had it, the Fed itself will have to pony up the money. This will put the dollar in further danger...along with the entire global financial system.

Koo may be right - as far as his thinking takes him. He should think a little further. The problem is debt. Too much debt in the private sector caused bear markets and a bank crisis. Too much debt in the public sector will cause big problems too - a default...and hyperinflation. Worse than a depression.

Bill Bonner
for The Daily Reckoning Australia

• U.S. Government Must Roll Over $3.4 Trillion in Debt Over Next Four Years
• Government Debt Bubble is What Directly Precedes Inflation
• What’s the Best Way to Get Through a Debt Crisis?
• Household Debt Represents Spending Taken From the Future
• In Europe, Banks Borrow Money and Lend it Back to the Government

"...if you want to stay with us you're going to have to straighten up ..[mother has a bad case of osteoporosis]...

"...no more drinking late at night. No more parties 'til 3 in the morning... No more sticking us with your gambling debts..."

"Oh...okay...but is it alright if I just sit in the corner and do my crossword puzzles?"

"Well, I guess so... Just don't ask us for anymore 8-letter words that mean 'a lot.' It's plethora. It's always plethora."

We made it very clear - she better mind her Ps and Qs or she's out on the street!

"But you're being very silly...as usual. I remember the real depression. I was born in 1921. So, I was 8 years old during the crash of '29. Then, I was a teenager throughout the depression.

"It wasn't anything like what is going on now...I remember my father was director of a local bank in Baltimore. My mother was ill, so he didn't want to trouble her, I guess. And I was so young I really didn't know what was going on. Then, one day Aunt Sophie sent a note with a news clipping, saying she was so sorry to hear about what had happened. I read the news. The bank had failed. My father had all his savings in the bank. When rumors began that the bank was going to fail, he felt couldn't pull his money out, because he was one of the directors. I guess you would say he went down with the ship. But he never even mentioned it. Even after we all knew, he acted as though nothing had happened.

"Then, he was too old to start over. All we had was the little farm. And we only had that because it belonged to mother. She was still ill. So I went down to the farm with her to take care of her while my father continued to work in the city. Then, he retired completely and came down too.

"I liked the house. You know...where you were born. But it didn't have heat, or electricity or plumbing. It was just an old farmhouse that had never been modernized. And then, in the depression, we didn't have the money to do anything to it. So, we just lived there as it was. It seems strange now. But then, a lot of people lived like that. We got water from a spring. We used oil lamps. In the winter, we had to start a fire to melt the ice water before we could take a bath.

"But by then the war had started. I remember sitting in the parlor listening to our old radio when President Roosevelt told us about the bombings at Pearl Harbor. I must have been in my early 20s. My father was home then and he told me that it wasn't a good idea for me to stay at home...I was too isolated. He suggested I join the WAC - the Women's Army Corps.

"Of course, that changed everything. I had never been away from home. And the next thing I knew I was on a train for Texas. That's where I met your father. He had just come from Pearl Harbor where he was stationed when the Japanese attacked. We met at a New Year's party. We wanted to get married right away...because he was leaving for the South Pacific...but I couldn't get married in Lent. So, we waited until after Easter."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Letter
• Henry Leaves for College
• Forgetful Bill
• Ron Paul Heralds a 15 Year Depression
• Unexpected Visitor at the Chateau in Ouzilly

What's a little odd about this story is that this woman has three grown children...six grandchildren...and even a great grandchild. Now, what's going on here? Are all those kids so heartless that they won't take in grandma? Or is grandma so insufferable that no one can stand her?

We always take the 'glass half full' approach here at The Daily Reckoning. So this reminds us of what is so nice about depression: it brings families together. It also improves manners. Grandmothers know they need to watch their behavior, or they'll be sent to a homeless shelter.

Once you knock them down it is harder than ever for grandmothers to get back on their feet. Why? They're not as flexible as they used to be. Besides, they have no way to earn money.

Mortimer Zuckerman, editor of US News & World Report, provides the figures:

Of people who are out of work, more have been jobless for longer than at any time since 1948. More exhaust their unemployment benefits before finding a new job than ever before. And if they are lucky enough to find work, they'll work the shortest workweeks since 1951.

In other words, the baby boomers have never seen times so rough...for themselves as well as for their children. One American in nine depends on the government for his daily bread. There are 6.2 million more people on food stamps than when the recession began. And there are 6 people waiting in line for each job opening, up from 1.7 when the recession started.

The baby boomers meanwhile figure they will have to keep working longer than expected. Sixty-three percent of them say they expect to delay retirement in order to build up more retirement savings.

This is bad news for younger workers, who were hoping the boomers would get out of the way to free up some jobs. Among young Americans, unemployment hasn't been so high since 1945.

If that weren't bad enough, the government has made things worse by increasing the minimum wage; that alone cost the young an estimated 300,000 jobs. In a depression, prices fall. The price of labor falls too...but not easily. That's why inflation usually helps increase employment - it lowers the real cost of labor. But people do not accept wage cuts readily. And then, along come the feds with a crackpot scheme to INCREASE wages...making the situation worse.

Naturally, Zuckerman looks at these facts and comes to the wrong conclusion. The headline:

"The free market is not up to the job of creating work."

"Only massive programs are equal to the challenge of restoring stable growth to our economy," he writes, in The Financial Times. What kind of massive projects? He mentions an "infrastructure bank." He might have said a war. WWII worked wonders for unemployment. All of sudden, anybody who wanted a job could find one.

But it's all hokum and claptrap. The Soviet Union put everyone to work. You can see where that got them. It's not the fact that people are sweating on a job site that makes a society prosper; they also have to be doing things that add to their wealth. Infrastructure, like any other capital investment, makes sense only when it pays off. The Japanese poured more concrete per square inch than anyone before or since. They proved that you can put up all the bridges and canals you want; it still won't restart the economy.

The free market is the only thing that can create worthwhile work. Because it is the only thing that knows - by sales and earnings - which projects make sense.

But we're facing a losing battle. People much prefer soothing lies.

Heck, we like them too.

Mundus vult decipi et decipiatur!

Bill Bonner
for The Daily Reckoning Australia

• Baby Boomers Are Ill-Prepared for Retirement
• Baby Boomers Face Early Retirement With No Money Saved
• Chartwell Enterprises – Pyramid or Ponzi?
• Consumer Economy Not Going to Return to Robust Growth Anytime Soon
• Americans Aren’t Borrowing Or Buying

And don't forget the foreclosures. They're running 23% ahead of last year...even though they weren't as bad last month as last month.

Associated Press:

"The number of households caught up in the foreclosure crisis rose more than 5 percent from summer to fall as a federal effort to assist struggling borrowers was overwhelmed by a flood of defaults among people who lost their jobs.

"The foreclosure crisis affected nearly 938,000 properties in the July- September quarter, compared with about 890,000 in the prior three months, according to a report released Thursday by RealtyTrac Inc. That puts foreclosure-related filings on a pace to hit about 3.5 million this year, up from more than 2.3 million last year."

What an economy!

The Dow is now back over the 10,000 mark...just where it was in March 1999 - 10 years ago. Is that progress...or what?

During that time, the dollar has lost about a quarter of its purchasing power. That means stock market investors have lost only about 25% or their money over the decade. Not too bad, huh?

And, oh yes...they've lost their jobs too...

AP continues:

"Unemployment is the main reason homeowners are falling into trouble. While the economy is likely out of recession, the unemployment rate - now at a 26-year high of 9.8 percent - isn't expected to peak until the middle of next year."

But hey...we're not going to complain. We've got a job - trying to figure out what is going on. And that is a job that is recession-proof. Everyone wants to know what will happen next. When times turn tough they want to know even more.

So, will someone please tell us what is going on...we want to know too!

"What do you think?" asked a friend at dinner last night. "The way I see it, Obama's goose is cooked. He's stuck. He can't go forward and he can't back up. He can't back away from all those promises - including his promise to rescue the US economy. If he does, the voters and his own party will revolt. On the other hand, he doesn't have the money to go forward. He has to borrow it. And if tries to borrow much more, the Chinese will revolt.

"His only hope is that the economy revives...so he doesn't have to do anything. And that's not going to happen."

Why not? Wait a minute...you already know the answer to that question. Because it's a depression. It's the end of the road for the consumer credit economy. Consumers did their best. They borrowed as much as they could. They spent like there was no tomorrow.

But now, it IS tomorrow. And now, they've got to settle up. So, boo hoo...no more wild parties. Daddy took the T-bird away. Get over it.

What should Obama have done? Nothing. But the last chief of state to do that in a time of financial crisis was Warren G. Harding - one of America's best presidents. That's what he did in the panic of 1920. How come we don't hear much about the crisis of 1920?

Because Harding didn't do anything; it went away.

But that was a long time ago. Now, presidents are expected to do something. They have too many people around them who stand to make a buck out of it.

Yesterday, Goldman announced its quarterly earnings. Goldman, you'll recall, is the firm that former Treasury Secretary Henry Paulson (a former Goldman chairman) called 13 times before breakfast during the financial crisis of last September. And Goldman is also the firm with its men in key posts in Washington, helping the feds figure out what to do with trillions of dollars in bailout funds (TARP, TALF, Fed's buying toxic assets, etc.)

Well, what a coincidence...now the firm says its latest profit is four times what it was a year ago.

The firm's "activities have become more profitable after the crisis reduced competition and governments injected funds in the banking system," says The Financial Times.

Goldman can borrow the funds at almost no cost. Then, it can use the money in a variety of ways...such as lending it back to the government for guaranteed profits...or speculating on oil or gold, or whatever. Not for nothing is gold is up 17% in the last six months. If you can borrow at zero cost you can do a lot of speculating. Many speculators are using the government's money to bet against the US dollar - and making a lot of money.

The US government has put $13 trillion of the nation's money and credit on the line. That's how much the feds have at risk on all their toxic asset purchases, loans and guarantees. Apparently, Goldman gets its share.

What can the feds do? Everyone is telling Mr. Obama that he must do something...now! So what does he do? Something stupid, of course.

Yesterday, poor Mr. Obama did something stupid. He said he wanted to send 78 million American seniors a check for $250 each.

What a nice Christmas present. But wait. Even Santa doesn't have that kind of money. The feds are already running a deficit somewhere close to $15 billion PER DAY.

But heck, who keeps track of these things? And who quibbles about a few billion more or less?

Not us. Not here at The Daily Reckoning. We've got other things to quibble about. In fact, we've got so many things to quibble about we hardly know where to start.

So let's just pick a news item at random and we'll begin our quibbling there. Here's one:

Social Security recipients are not going to get a COLA. A COLA is a "cost of living adjustment." It's what Social Security recipients get when prices go up. It adjusts their payments to inflation.

COLA seemed like a fair idea when it was put in place. That was when prices were going up. The old folks were getting a raw deal and people felt bad about it. We remember those years. There was a report in the press in the late '70s that old people were "forced to eat dog food" to survive. We suggested that the government allow people to use food stamps to get pet food. But that was greeted like so many of our attempts to be helpful.

The trouble with the COLA is that there is no UN-COLA. When prices fall, there's no way to get the money back. The adjustments only go in one direction.

And prices ARE falling. US import prices roes only 0.1% last month...down 12% from a year ago. Take out energy and they're still down 4%. And that's with a dollar that is losing value at the same time. Imports should be going up in price. Instead, the downward tug of deflation is so strong that they are pulled down...even with the dollar buoying them up.

So, imagine that the United States slips into a Japan-like slump...a long slump with off-and-on falling prices. The government's budget projections call for a rapid return to growth. Even then, they expect trillion-dollar deficits until the end of the next decade. But if the economy does not return to rapid growth, the situation gets much worse - fast. Tax revenues don't go up...and spending continues to mount. There's no way to reduce payments to Social Security recipients. And imagine the poor sap who proposes it. Or who suggests that maybe government salaries don't have to be twice as high as private salaries. He wouldn't last long.

This leaves the feds in a tight spot. They won't have trillion-dollar deficits...they will have multi-trillion-dollar deficits. They won't have just a little trillion-dollar hole to fill; they will have a Grand Canyon.

How to fill it?

Ain't no way... Ain't no way... At a certain, but unknown, point the whole thing falls apart. The feds can't raise enough money. They go broke.

Now, hold on...the US federal government can't go broke, can it? Those fellows have a printing press. They can print their way out, no?

A very, very good question. Why would a government with the power to create money at will ever go bust? And yet, they do. Why? Because it is cheaper.

But this is far too large and important a subject for a Friday. This is a subject for a Tuesday. Maybe even a Wednesday. But Friday? Nope. God didn't make Fridays for this kind of thing. We'll have to come back to it next week.

Can anything stop the Chinese?

"China consolidates its lead in world trade," was a headline in The New York Times earlier this week.

China competes on price - and usually wins. America loses market share.

"We're finished," said our dinner companion last night. "We're fossils. We're yesterday's news. We're a nation of old people. The growth and innovation is taking place elsewhere - such as in China. You can feel the difference when you go there. New buildings. New roads. New cities. New shoppers. Here, everything is old. The buildings. The people. Everything.

"I tell my children to move to the Far East. We're history here."

This morning comes news that the Chinese have bought another auto company - Britain's van maker, LDV. And over on page 11 of The Wall Street Journal is a photo of the head of China's big bank, CCB. Asked about whether the bank was looking at acquisitions in the West, Mr. Guo Shuquing said he wasn't interested. Western banks are on a "downhill path," he said.

"Of course, there's something nice about living in a society which has peaked out," our friend continued. "You have all the grace and style of an advanced civilization without the annoying hustle and bustle. It's perfect for retired people...We live in a retirement society."

Bill Bonner
for The Daily Reckoning Australia

• Feds Have Economy on Life Support
• China’s Economy is Now Freer and More Competitive than the United States
• Have the Feds Given the Economy a Miracle Drug?
• If the Economy is Not Recovering It Isn’t Getting Enough Stimulus
• Rising in Defense of Goldman Sachs