The challenge of today's Daily Reckoning is to separate the short-term trends in financial markets from the long-term trends in geopolitical history. It's a big challenge. But let's break it down and see where we go. And let's begin with U.S. Bank Wells Fargo.

The Dow Jones slipped under 10,000 at the end of the day Wednesday largely because analyst Dick Bove changed his call on Wells Fargo from "neutral" to "sell." Bove said the quality of the company's third quarter earnings was, "pretty poor." "If you take a close look at the earnings, what you can see is that the improvement is due to a hedging profit made on the mortgage service portfolio, about $3.6 billion...You can also see that they cut their tax rate," he told Dow Jones news wires.

Imagine that; a major bank boosting earnings with one-off events. This is why we said last week that quarterly earnings (and whether they are above or below analyst expectations) don't always tell you what you need to know about a business. Granted, Bove is still bullish on Goldman, Morgan Stanley, and Bank of America. But his comment set off a small chain reaction on the Street.

It was a weird reaction too. Stocks fell and the Aussie dollar briefly faltered against the greenback. But commodities like oil and gold continued to power ahead. Oil is at a 12-month high and trading over US$81. Gold futures again traded above $1,060. And the U.S. dollar kept falling against commodities and other currencies.

So does this disprove our trading idea that the dollar index is due for a rally? Nope. The index could make a new low below 70. And that would certainly confirm what we already know: the rest of the world is on to America's habit of living way above its means. The dollar index could plumb a new low until there is an improvement in America's trade deficit or its fiscal deficit. However...

Don't discount the rally! "We should be prepared for a counter trend rally," wrote Slipstreamer Murray Dawes earlier this week. "RSI are entering long term oversold levels (although in a downtrend they can remain oversold for long periods of time of course and so are not a good trading signal against the trend) and market news is constantly bearish the US dollar so trader positions may be getting a bit full up on the short side."

"A short squeeze would not be out of the question, but I would not be trading a squeeze unless it breached the 81 level to confirm the re-entry into the last year's range," Murray concluded. A short squeeze in the greenback would see oil and gold correct, along with the Aussie dollar and stocks. Mind you this is a trading trend, not a long-term investment call. But we're tracking it and will keep you posted.

For a top-down view of just what's happened to the dollar this year and what it means for your investments, have a read of David Einhorn's speech at the Value Investor's Conference in New York City. It's a real page turner. And it's only eight pages!

Einhorn made a few great points worth considering. The first is that Australians should watch out for a second period of slower growth (maybe even recession) once the effects of the stimulus exhaust themselves. It wouldn't be the first time something like this happened. The attempts to stimulate America out of the Depression boosted GDP for a few years, but didn't solve any of the problems which really ailed the economy.

"An alternative lesson from the double dip the economy took in 1938 is that the GDP created by massive fiscal stimulus is artificial. So whenever it is eventually removed, there will be significant economic fallout. Our [America's] choice may be to maintain large annual deficits until our creditors refuse to refinance them or tolerate another leg down in our economy by accepting some measure of fiscal discipline."

Einhorn is writing about the U.S. In Australia, the government is hoping the removal of the fiscal stimulus won't result in "significant economic fallout." It must be hoping that capacity expansion by the mining industry is enough to support employment and consumer spending...and that house prices (and home building) keep the rest of consumer spending buoyant...and that businesses begin to reinvest.

That's a lot of hope. But hope has been pretty easy to sell these days.

The other factor which makes Australia's situation slightly different than Americas is that funding Australia's comparatively small deficits shouldn't be too hard, given the strength of the Aussie dollar. Not that racking up long-term debts to China or other foreign creditors is good, especially when the borrowed money is just going to your mates in the building industry or to prop up select retailers.

But it's probably true that Australia's creditors won't squeeze the government until much later, after the current government has been replaced. That will happen years down the track, when tax payers will still be paying off today's debts. Perhaps they will be wondering why no one [today] thought it was immoral to steal money from the future in order to maintain over-leveraged lifestyles today.

But that is the future's problem. So we'll let them deal with it. Einhorn is right to point out that policy makers tend to favour short-term benefits over long-term prudence because it's easier to get elected that way. And news organisations always spin the policy in terms of who the narrow groups that benefit rather than the unknown parties in the future that don't. But maybe this is just too abstract a point for people to understand these days. In any event, years down the track when Australia is paying off its debt to foreigners, the question may come up again.

Today, there are other more critical events that could rock financial markets. "As we sit here today, the Federal Reserve is propping up the bond market, buying-long dated assets with printed money. It cannot turn around and sell what it has just bought," Einhorn says.

The Fed has no exit strategy! The U.S. bond market has become a quagmire from which Geithner/Westmoreland and Obama/Johnson cannot escape! But hyperbole aside, what does that really mean?

It means that TARP and TALF and CAP may eventually wind down. But the Fed is subsidising mortgage rates and short-term Treasury rates in the U.S . This is what's going to drive the next down move in the dollar and the dollar index (it will make new lows). The Fed will continue "monetising the debt" and there will be fewer and fewer foreign takers (willing to finance U.S. deficits by buying bonds and notes).

This quantitative easing is incredibly bullish for gold. And it's a liquidity trap for the Fed.

"There is a basic rule of liquidity," Einhorn says. "It isn't the same for everyone. If you own 10,000 shares of Greenlight Re, you have a liquid investment. However, if I own 5 million shares it is not liquid to me, because both the size of my position and the signal my selling would send to the market. For this reason, the Fed cannot sell its Treasuries or Agencies without destroying the market. This means that it will be challenged to shrink the monetary base if inflation actually turns up."

We'd argue there already IS inflation, but it's in assets...stocks, bonds, commodities, and real estates. The Fed's nightmare is that it is unable to shrink the monetary base without collapsing the Treasury market (sending yields to the stratosphere). You'd get a collapse in asset values and devaluation in the dollar, which, in the real economy, would lead to rising prices. A loss of net worth coupled with a rising cost of living...is not a good formula for getting re-elected.

And one more point on the U.S. debt. It is now extremely interest rate sensitive, as we wrote here in April. Einhorn writes that, "The Treasury has dramatically shortened the duration of the government debt. As a result, higher rates become a fiscal issue, not just a monetary one. The Fed could reach a point where it perceives doing whatever it takes requires it to become the buyer of Treasuries of first and last resort."

Besides taking U.S. monetary policy into the land of the absurd, you would also want to buy long-dated calls on U.S. interest rates if Einhorn is right. You can trade it two ways actually. You can be short U.S. bond prices through exchange traded funds like TLT and IEF, or long U.S. bond yields by buying call options on U.S. Treasury yields.

And what about the other dodgy currencies like the Euro and the Japanese Yen? They are doing well against the Greenback now. But at a fundamental level, both have the same genetic defects as the U.S. dollar. "I believe there is a real possibility that the collapse of the major currencies could have...a domino effect on re-assessing the credit risk of other fiat currencies run by countries with large structural deficits and large, unfunded commitments to ageing populations."

The "domino effect" Einhorn is referring to is the collapse of Lehman Brothers. For at time, until it was clear the government would not allow the other investment banks to fail, it was clear to investors that if Lehman's leveraged model was dead, so was Goldman's and Morgan Stanley's and Merrrill Lynch's.

In a world where credit was not so ready and the unwinding of leveraged assets threatened to wipe out equity capital, those major levered up firms faced an existential threat. The government stepped in at that point and bailed them out, preventing the free market from doing what it was about to do: punishing the firms, their creditors, and their shareholders for incredibly bad risk taking.

Now you have the goofy situation where a government pay Czar is intervening to cut executive salaries at those firms by 90%. If the government hadn't intervened in the first place, the salaries would have been cut by 100% and the bad bets by the firms would have been written off and the economy would be closer to recovery. But that is neither here nor there.

Einhorn's warning is that currency devaluations force investors to revalue the idea that sovereign bonds are risk free. This is another way of saying that the nation state as a fiscal enterprise is every bit the failed model that investment banking is today. Investment banks borrowed money to bid up assets. Governments borrow money, securitised by tax revenues, to "invest" in policy objectives.

But as we are finding out now, those "investments" have not been self-sustaining in an economic sense. Einhorn, if we read him right, is reaching the conclusion that the nation state financial model (the fiscal warfare/welfare state) is in deep, deep trouble. It is the next institution that is "too big to fail." And it's going to fail because its funding model is based on the fraud of an idea that we can all live at one another's expense and that you can get something for nothing.

Here's a question, though: who bails out a failed nation state? Will the IMF bailout America? Will the World Bank lend to Japan? Will China establish a line of credit for Europe?

Speculators who like what Einhorn is saying would consider buying long-term put options on the Euro and the Yen too, not just the U.S. dollar. But what do you do if you're not George Soros? Why not try gold?

"I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible."

Sounds pretty sensible.

Dan Denning
for The Daily Reckoning Australia

• Recession Where Short-term Benefits of Consumption Belie Long-term Debt Consequences
• U.S. Treasury Auctioning Off $81 Billion in New Debt
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• HSBC Reveals Days of the Dollar are Numbered
• U.S. Government Must Roll Over $3.4 Trillion in Debt Over Next Four Years

And on to today...Shouldn't this be an interesting week? "Markets have gone up too much, too soon, too fast," says Nouriel Roubini. The ASX 200 fell nearly 100 points on Friday, or 2.11%. This echoed the previous day's trading in New York.

Friday wasn't so bad on the Dow. But the jobs report released by the U.S. Department of Labor showed 263,000 lost jobs in America and an official unemployment rate of 9.8%.

That rate is undoubtedly much higher, once you figure in people who've given up looking for work but are no longer included in the survey. In fact, the "U-6" figure kept by the Department measures labour "underutilisation" in the economy. And according to that figure, U.S. unemployment is at 17%, nearly twice the figure quoted on Friday.

There have been jobless recoveries from recession before. But you still have to wonder how there can be such a big difference between the stark news in the job market and the behaviour of the stock market. True, economists will tell you that jobs are the last thing to recover from a recession. Businesses don't hire until they are sure everything is in the clear.

And we are often told that stocks lead the economy. The market has priced in a recovery which the labor market will confirm...eventually. At least that's the conventional wisdom. It's reassuring.

But the unconventional wisdom is probably more correct. The unconventional wisdom is that low interest rates (near zero in the U.S.) have driven people out of cash and forced them into higher-yielding and often speculative assets. The biggest obvious beneficiaries of low rates and credit facilities has been financial sector stocks themselves (and presumably their options-laden directors).

The question this week is whether there is any momentum left in that trade. Can easy central bank policies keep stocks going higher? Or has the trade exhausted itself? And if it has, what happens next?

Well, one answer is that you may again see a mini-rally in the U.S. dollar and a fall in common stocks and commodities (oil and gold especially). We'd expect this to a cyclical dollar rally. In the bigger picture (a secular trend) the dollar is toast. But markets do not move in linear fashion. They give and they take. And the dollar may be due.

If we do get a greenback rally, this may pave the way for a higher Aussie gold price. The strength of the Aussie dollar has capped the gold price here in Australia. But we reckon you may get a nice move in the Aussie gold price if the greenback rallies. The question is whether U.S. dollar strength takes gold down too, neutralising the benefit of the weaker Aussie.

How do you sort out the relationship between two currencies, one commodity, and many stocks? It all sounds complicated. That's why we've added another mind to the trading desk here at Daily Reckoning Australia headquarters on Fitzroy Street. Murray Dawes is at the helm of the trading desk today. We'll keep you posted on what he has to say.

One question we'll have for him: what the heck should investors do with Woodside Petroleum (ASX:WPL)? Dow Jones newswires is reporting that over the weekend, Federal Resources and Energy Minister Martin Ferguson awarded permits to explore ten new off-shore oil and gas blocks in the Carnarvon Basin off the Northwest coast of Australia.

Woodside is one of the firms that won a permit. Ferguson said that, "The additional investment in Australia's offshore petroleum exploration sector not only offers exciting potential for petroleum discovery but will ultimately help to further develop our petroleum resource and underpin our security of energy supply,"

The security of Australia's energy supply is exactly the issue our special situations analyst Mike Graham took up in his research about Australia's oil industry. You can find that complete report here. The findings may surprise you.

With respect to Woodside, there are not too many better blue-chip energy stocks in Australia. Unlike the smaller explorers though, the blue chips are valued differently. Adding to their reserves is crucial, so that the company is not inexorably depleting its assets. But the energy blue chips like Woodside are well known by analysts and they are well-traded by institutions.

This, in our mind, makes Woodside a perfect candidate for a Slipstream trade. That is, if we were a full time trader, we'd be looking for a pattern in the stock chart to see where key levels of support and resistance were. But since we don't run the trading desk, we'll ask Murray and see what he says.

Today's thought of the day from John Robb at Global Guerrillas, "The American 'kleptocracy' has run out of steam due to too much debt and is already in the midst of a perpetual depression. Why? The US middle class -- faithful to the cult religion of free markets even while being taken for all they are worth via a 35 year process of substituting debt accumulation for income gains -- is financially broken. If this is even remotely true: is the US headed for Privatopia and the viral spread of Global Guerrillas?"

Substitute "Australia" for "America" and it makes just as much sense, doesn't it?

Dan Denning
for The Daily Reckoning Australia

• Looking at WPL and Oil Side by Side
• Apparently More Debt is Now Acceptable in Australia
• Commodities Tell Us the World Won’t Stop Turning in a Financial Crisis
• Oil Prices Under $70
• The Future of the Australian Resource Market, Two Ways the Boom Could End

Both the S&P 500 and the Dow Jones Industrials closed up about 2.5% overnight. Analysts upgraded estimates for Goldman's earnings. That sparked a buying frenzy in bank and financial stocks, which took markets higher. Presto, change-o, everything is bull again.

Or is it? We'd suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America. However, that doesn't mean the pair trade doesn't have legs. In fact, have a look at the chart below and you might be convinced it's time to buy the S&P!

Click to enlarge

Thanks to massive stimulus from China beginning in November, there's been an explosion in consumer and business lending. That's translated, we'd suggest, into asset inflation. Exhibit "A" is the nearly 75% year-to-date climb in Shanghai's benchmark CSI 300 index. It has, as you can see, trounced the return in U.S. stocks.

Now there's more than one way to interpret this chart (this is what makes charts so intriguing but frustrating.) Is this the market's verdict on U.S. growth prospects and Obama's trillion dollar deficit plans? Is it vindication that China's stimulus has been a lot more successful and promoting real economic growth than the $787 billion pile of junk passed by the U.S. Congress?

Or how about a third theory? Is it evidence that China is in the accelerating phase of its own massive credit bubble? And could the collapse of this credit bubble lead to a Chinese Day of Reckoning?

If that's the case, then it would be time to sell commodities and buy Goldman, or at least time to sell commodities. A collapsing Chinese credit bubble would remove a lot of the demand and price support for Australian commodities (especially coking coal and iron ore). We covered the story while filling in for Kris Sayce at Money Morning today. You can read the whole story over www.moneymorning.com.au.

While we're on the subject of stimuli, a New York Times story from yesterday suggest that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble. But the evasion is like hiding under the bed from the bogeyman. He's still going to get you. Sucking your thumb and pretending otherwise won't help.

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

This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now. The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they'd got a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent). Yet many banks are under the absurd illusion that if they hold certain assets to maturity, they won't suffer any losses.

This is the same as saying million of Americans are going to make their mortgage payments as they lose their jobs and find themselves underwater and unable to refinance. The default and foreclosure data coming out of the U.S. housing market suggest the banks are kidding themselves, or misleading shareholders, or both!

It's the sort of calculated mis-truth that can cause a short-term crisis to last years and years. The correction is postponed through phoney accounting. It leads to a Ushinwareta Junene, or a lost decade, as the Japanese say. We prefer the Zombie metaphor-an economy full of living dead loans that threaten to infect the real live survivors.

In a ten (or even 17 year period like that) you get low growth, high unemployment, and stock market benchmarks that do not keep up with inflation. Stocks as an asset class perform poorly. Bonds, on the other hand, might go through rallies and corrections and be more tradeable (or rally on deflation concerns, as Marc Faber pointed out late last week).

But whatever happens in ten years from now, it's pretty clear that the "doing something is better than doing nothing" mantra of Keynesian intervention is a big fat deficit-adding failure. Unemployment is rising. The economy is not fundamentally better off. And bank balance sheets retain a whiff of unreality. More spending cannot be the answer when too much credit was the problem.

-Phillip J. Anderson is one of our panellists at the upcoming "Australia in the Red" summit in Melbourne on Friday, July 21st at the State Library of Victoria. In his book "The Secret Life of Real Estate," he explains a 17-year cycle in property prices related to land values.

Fortunately for Aussies, the cycle heads mostly up. Not so fortunately, there are periods in the cycle where it corrects and falls in real terms. If you buy near the top and prior to a four-year period of decline, it can be bad for your financial plans.

We're not sure why, but this idea that cycles run in 17 or 18 year periods keeps cropping up. Last week on CNBC, Art Cashin made exactly the same point. He pointed out that from 1966 to 1982, the Dow Jones traded in a range.

If you began investing in 1966, you didn't make much money for the better part of two decades. On the other hand, the 1982 to 2000 cycle witnessed one of the greatest bull markets of all time in stocks. Get your timing right and get in the right asset class and cycles do your work for you. Or so it would seem.

Our sense is that right you have a lot of competing cycles. You have a historic low in interest rates across the globe. That led to a period when the cost of capital was incredibly cheap. This kick started an industrialised production boom in the developing world which has a momentum of its own. But is it sustainable?

You also have demographic and psychological and simple life cycles. As affluent Western investors get older, they seek to cash in on accumulated gains and enter into a golden retirement. Where will the money to move markets higher come from? An increase in mandatory superannuation contributions?

We'll leave you today with a nearly incomprehensible chart that shows an even more intriguing longer-term cycle. The char appears to show that global energy production per capita has peaked and is headed for permanent decline...in other words...industrial civilisation has a lifespan of around 100 years...and we have reached that life span.

That would seem like bad news. Of course, perhaps post industrial civilisation will be a more pleasant place, albeit with fewer calories and no climate control. In all seriousness, though, if there is any truth to the idea that energy production per capita has peaked, it means China has picked a very bad time to have an energy-intensive industrial revolution. And to the extent Australia is now dependent on China for its prosperity, well the consequences are self-evident.

If the Credit Depression coincides with the Energy Depression, then you'd want to consider a very different financial survival strategy. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Traders Sell Bank Stocks Due to Goldman Sachs Surprise
• Business Cycle Theory Explained by Joseph Schumpeter
• Meredith Whitney and the Buy Recommendation on Goldman Sachs
• The ASX Bubble, Fueled by China
• JPMorgan and Goldman Sachs Making Billions in Profits

Don't ask us how it happened, but we linked to the wrong YouTube video in yesterday's DR. We meant to link to this song from David Gray. Instead you got the Jonas brothers singing "Lovebug." We can assure you that will never happen again.

One more housekeeping detail. At the suggestion of our web guru, we're Twittering. It appears to be the most superficial and vacuous form of web-based communication ever invented.

Come to think of it, the modern world of telecommunications gives you so many ways to communicate instantly. But we reckon that even though there are more ways than ever to say something, people are actually saying less and less of value. There must be some hidden ratio between the content of actual communication and the number of media in which to communicate.

In any event, we will use the Twitter to communicate vital information about our publishing schedule or things like that. To follow us on Twitter go to http://twitter.com/draus.

Let's get right to the mailbag today.

Dear Dan

You wrote that 'Even in the middle of the Great Depression, the market was capable of staging mammoth rallies that would tempt investors back in. No doubt those were extremely tradable rallies. But they were followed by lower lows once the forces of economic and earnings reality reasserted themselves on the collective mind of the market.'

I am a regular reader and appreciate your views. Who knows (certainly not me) what myriad similarities and differences exist between now and the 1930s but I don't think your assertion is correct. All the charts I have seen show that the low point in 1932 was never even close to being revisited - the massive depression rally from 1932 which you mention never retraced anywhere the 1932 low - i.e. the bear market from 1936 til 1942 never went anywhere near the 1932 low. So the 1932 low was very literally the buy of a lifetime!

Having said that, I am also aware that interpreting indexes as opposed to the real world is risky because bad performers are eventually removed and replaced with good ones which to some extent must account for the long term upward trend.

Cheers

Ross

You're right Ross. We went back and looked at the S&P in the 1930's and it never did re-test the '32 lows. See the chart below. Some fortunes really are made in a recession!

As you point out, long-term index returns have a survivor bias. The bad companies are weeded out and new ones added. Today, you could by an index-tracking fund and simply forget about it for twenty years, if you thought the lows have been put in. You'd just have to hope that the stock market goes up faster than the rate of inflation.

Click to enlarge

Dan,

When you say 'climate change hysteria' have you discovered some new information that flies in the face of general scientific option, or are you just another baby boomer unwilling to make any financial sacrifice to help protect the planet for future generations?

David

Is this an ad hominem attack? Hmmn. It's become vogue to assert that the science on climate change is settled and that unless you're a complete moron, you can't credibly dispute it. But that's simply not the case. Check here and here. David Evans and Joanne Nova (both DR readers) point out that the model used by the International Panel on Climate Change is flawed and there is simply no evidence that carbon emissions from man-made industrial activity have warmed the planet.

The earth's climate is an extremely complex and dynamic system. You would think any scientist who actually uses the empirical method would be extremely cautious about making definitive statements about a system with so many variables. It seems a little arrogant to suggest we know exactly how it all works and can say with precision that human activity is solely responsible for the warming of the earth (it's not even warming).

When models are flawed their conclusions are worthless. Garbage in, garbage out. The IPCC model is flawed. But that doesn't bother the people pushing the climate change agenda. In fact, the real agenda behind the climate change argument is to tax carbon and create a huge new source of government revenues. You can only raise income taxes so much before you start to kill productivity in an economy.

If you want to get philosophical, the climate change argument is also a government power grab. It's just another excuse for the government to get right into your personal life and control the decisions you make. Climate change has been cleverly marketed as a moral issue with which you can shame people into "financial sacrifices," which is just another word for higher taxes.

So yes, there is plenty of information that clearly disputes and refutes the idea that human beings are causing the earth to warm. We're more than comfortable being a sceptic on this one. And no, we're not a baby boomer.

Dan

I am a little slow on the uptake at times (can sometimes be an advantage) and I am struggling a little with how inflation is so bad for us holding wads of Australian pesos. When inflation was high (recently) so were the rates I was getting on my online savings accounts. Is it because the rate of inflation will far exceed what I can gain back with interest? Either way I am going to see my buddies at the mint. On that subject can you shed a little light on what the US government did with gold in the 30's? I heard somewhere that they set the price of gold (at a low price), made it illegal to own gold (except for items of religious significance - constitutional hiccup for the government) and then bought it back off you at the discount rate. Love your work. Look forward to my daily chuckle from a select few who are not sheep.

Cheers

Shannon

Thanks Shannon. Inflation is a tax on cash. The longer you hold cash when inflation is soaring, the more purchasing power you lose. Just ask pensioners living off saved income. Low interest rates may be great for new home buyers. But for pensioners, interest rates below the rate of inflation have led to a decline in real income.

This is why it's so criminal and immoral that governments are now actively pursuing inflation with greater gusto. They say it's done to stimulate aggregate demand so the economy does not grind to a halt. But over the long-term, it makes for price instability. People can't plan or save or invest because there is so much uncertainty about something so basic to economic life: the price and value of your money.

Pursuing inflation also shortens people's time horizons. We'd argue this discourages businesses from making long-term plans (capital investments that might take years to depreciate and require huge investments). When you disincentive saving you get people living for today and not really doing the kind of careful long-term planning an economy needs to be productive and raise living standards over time.

And since we're in a philosophical mood, we'd also suggest that when the value of your money is diminished, it distorts personal values as well. Having a walk down Chapel Street the other night after coming home from the footy, we saw some pretty outrageous public behaviour. You see people behaving in ugly ways which show they have no respect for other people and probably very little respect for themselves.

We'd suggest this kind of behaviour is a symptom of a culture in which values are eroded by the instability of the financial system, and that all begins with sound money. If you have unsound money, you'll get an unsound culture and all the problems that come with personal behaviour that's influenced by abundant credit. Credit excess becomes behavioural excess.

By the way, the government did confiscate gold in the 1930s as you point out. The Feds didn't want any competition for their own money product. They knew that the only way to prevent people from preferring gold to the dollar was to make owning gold illegal. Ever since then, there's been a war on gold for the threat it poses to the planned path of regular inflation. It's no wonder we're in such a mess today.

One final letter.

One question for the team which has me a tad bemuddled. If all currencies devalue by say 40% equally, then why does devaluation matter? I concur that the best protection of wealth is precious metals, base metals, real income producing assets which income is variable on demand, but as far as currencies go - who cares unless you are a player of the currency markets?

Another matter, I have always used the conventional balance sheet method of analysing economics. A standard profit and loss statement [for Australia the nation] should be:

Income

Mining

Manufacturing

Agriculture (export)

Less Cost of sales

Transport

Communications

Research

Labour

Defence

Infrastructure

Result = Gross Profit

Less Overheads and expenses

Banking, Finance

Interest on Capital loans

Health & Social Security

Private Housing for employees

Immigration & other benevolent departments

Result = Net Profit

As a guide, the world consumes base resources, like food and base materials. These will always survive a downturn providing they are not exposed to poor health, bad bankers or devious governments.

Any comments?

Just a few. Bankers have been pretty bad lately. And governments are always devious. But your point is well taken regarding national income. Would you include government in your cost of sales? We would.

That's one reason rising government spending as a percentage of GDP is so worrying. The government doesn't really add any productivity to the economy. It just gets involved in a lot of transactions so it can generate revenue for itself which it then redistributes to favoured constituencies.

A big question for the Australian economy how well national income holds up if the global recession lasts a lot longer. At the household level, you have a lot of people with a lot of debt who face lower real incomes (adjusted for inflation). At the government level, unemployment and the correction in commodity prices have blown a big hole in government revenues. The government hasn't really adjusted its spending plans yet to reflect lower revenues. They never do of course. Spending always increases.

As to competitive devaluation, your point is also well taken. What you have, though, is a race to the bottom in which everyone is getting poorer at an accelerating rate. On a relative basis, it might not look like much has changed. You're all falling at the same pace. But on an absolute basis, debasing the currency triggers a host other financial consequences. We'd argue that adds up to a lower standard of living, which is why we're against it. Hitting the bottom is no fun.

Dan Denning
for The Daily Reckoning Australia

• An Old Friend With a New Idea on Global Warming
• What Assets are Going to Beat Inflation in the Coming Ten Years?
• Climate Change and Hyperinflation Reader Mail
• Gold Outlives Paper Money, Empires and Governments
• Debunking Inflation Myths

Besides, stocks have been a bad bet for the last 12 years. They're now back to '97 levels...meaning, investors have made nothing for a dozen years. Stocks for the long run? How long do you have to wait?

And now, the stock market is breaking down...again. Dow Theory has given a Bear Market Signal. What that means, exactly, we don't know. Stocks will go down until they stop going down, we guess.

Citigroup is moving "closer to toast," the New York Times reports. The market cap of Citigroup has fallen by more than 50% since Monday. "I think it is going down," writes old friend Jim Davidson. "My best guess, it will be nationalized...on a 'temporary' basis."

Many are the economists urging the government to nationalize the big banks. People need confidence in the banking system, they say, or we'll all be toast.

Among the big names in favor of nationalization is Nouriel Roubini, one of the few economists who seemed to know what was going on. He saw the crisis coming and said so. Now, he's practically a media star.

Of course, we saw the crisis coming too...here at The Daily Reckoning. We said something too... But we're still waiting for the press to call...just so we can hang up on them. The worst thing that can happen in this trade is success. It makes you think you know what you're talking about. The next thing you know, you're giving advice to central bankers and major corporations. Then, the gods get their backs up. Everyone starts believing what you say...even you.

If we were in charge, we'd get out the toaster. But nobody asks our opinion. And it's probably a good thing. Because when people come to think what you think, what you all think is probably wrong. At least, that's the way it tends to work in the financial markets. As soon as everyone gets on to a trend, it is soon over. Back when the going was good, for example, everyone thought it would be good forever. Naturally, it stopped being so good soon after.

Now, what does everyone think? Hard to say. We read the headlines and try to figure it out.

"In Gold We Trust," says a headline at the Wall Street Journal. Gold fell back below $1,000 yesterday. The yellow metal seems very popular. Maybe too popular. But does everyone think gold is going up? We hope not; if they did, we'd have to sell.

Still, most people still think gold is a little kooky...the kind of stuff that grumpy old men bury in their back yards. And most professionals, too, still think gold is weird - an investment for grandpas. 'Worried about inflation?' they ask. Then, solving their own problem: 'Just buy TIPS. You know, government bonds indexed for inflation. You'll collect some interest...and you'll be protected against inflation. These bonds are indexed to the CPI.'

TIPS are cheap. That is, you don't give up much yield to get the inflation protection. But if investors can get protection from inflation for only, say, 1% of yield...what does that tell us? Well, it tells us that investors think the rate of inflation over the next 10 years - TIPS are equivalent to 10-year notes - will be only about 1% per year.

People don't call an exterminator when they have no pests. Gold is protection against inflation. They don't usually buy gold when they don't fear inflation. The TIPS premium - the extra that investors pay (or the yield that the give up) - is so low, it tells us that investors aren't afraid of inflation.

What are they afraid of then? Why is gold going up? What is it that everyone thinks?

Our guess is that people don't know what to think. Some - and only some - are hedging their bets by buying gold. Something funny is going on, they must think. They don't know exactly what it is, but they're sure it won't end well. They buy gold...just in case.

We continue to hold gold because we know it is the ultimate store of wealth... Think about it this way. No paper currency has ever stood the test of time. They've all eventually become worthless pieces of paper. But gold has not, and will not. This is why it is the ultimate hedge against inflation...against uncertainty in the markets...and is the anti-paper. This is why we hold it...and why you should do the same. Find out how you can get the precious metal for just a penny per ounce. See here.

So, the major trends continue. Stocks go down. Gold goes up.

*** The S&P 500 took quite a beating last week. After breaking through near-term support at in the 804 area - the bottom of the market's intermediate trading range - stocks are now poised to test November lows at 741 on the S&P. But Easy Money Options' Wayne Burritt thinks, if history is any guide, that the market may be poised for a bull run.

"The recent technical action is shaping up much like the market's recovery after the dot-com fiasco. Back then, the S&P tested the 769 to 789 level three times in the eight-month period between July 2002 and March 2003. Each time the levels held and after the third was over, the market commenced a spectacular bull run.

"In fact, from its jump-off point of 783 in March 2003, the market didn't stop until it reached 1576 in October 2007. That's a staggering 101% gain in just over four years.

"Today, the markets are wrestling with similar lows in the 741 area. It made its first test in November and succeeded. It's now in the midst of a second test. If my thinking is right, it will test that low, recover and then test it once again. After the third, a new bull run could be in the cards."

Wayne does admit that the fundamental pressures of today are much worse than following the dotcom bust...and that means the market bias going forward is certainly to the downside.

However, Wayne has his sights set on a handful of companies that are prepared to move up - no matter what the broader market does.

*** Looks like Paul Volcker is channeling Gloria Gaynor...

Volcker, former head of the Fed and hero of the inflation fight of the '80s, says of capitalism: 'I will survive, I will survive.'

We did not read Mr. Volcker's speech. But we can imagine it. Capitalism, in its various forms, has been around for a long, long time. It is unlikely to go away, simply because everything else is a fraud and a scam.

What a delight to see Mr. Volcker rise to defend capitalism. The old creed needs a lift. Every crackpot and malcontent on the planet is gunning for it - including Danny Ortega, here in Nicaragua.

What is capitalism, after all? It is not a system...not a plan...not a program. It was not decreed by any half-wit tyrant...nor written into law by any earnest assembly. It has no constitution...and no boundaries. It is merely a recognition of basic principles. 'Thou shalt not steal,' it says in the Bible. Capitalism recognizes other peoples' property. The baker has a right to his oven. The farmer has a right to his land. The capitalist has a right to his money. What they do with these things is up to them.

Will they make mistakes? Of course they will. Will they do evil and obnoxious things? No doubt about it. Will they occasionally lose their heads and overprice their assets...or run the whole economy into too much debt...or blow themselves up in a bubble? You bet.

As Adam Smith described, they will also bumble along to create the wealth of nations.

But larceny wasn't invented in the 21st century either. Naturally, people want what the capitalists have. Everywhere and always, the thieves will find reasons why they should be able to take it from them. They will respect the environment better, they say. They will invest in 'socially responsible' projects, they claim. They will heal the lame and make the blind see. If only they get their hands on your money!

• Stocks and Gold Are Going In Opposite Directions
• The Stinging Reproach of a Former Fed Chairman
• Consumer Price Inflation has Spooked Investors Everywhere
• The Correction in the U.S. Housing Market Made Its Sharpest Move Ever
• Gorbachev and the Most Complete Test in Economic History

But our focus today is oil itself. That’s where the market is focusing. Oil’s what equity traders are looking at.

The big question: is this short term selling or a medium-term switch in trend? I mean, in early June, the oil price slipped from US$135 to US$123. Then it bounced back again.

Really, there are a lot of questions over the oil price at the moment. Does this correction mean we won’t reach the levels of $200 or even $250 that a few analysts have forecasted? Or is this a consolidation phase before renewed strength?

We can’t answer all of those for you. Some of them depend on the future. But we can definitely clarify the charts for you…and why they’re more important today than ever.

Obviously nothing has really changed on the fundamentals side. Master Card recently announced that in June US petrol purchases decreased by 3.9%. And that’s not a new trend. US crude demand has been lower all this year.

But the funny thing is, fundamentals aren’t moving the price any more – in either direction. The ebb and flow of military activity in Nigeria, for example.

Normally when militants offload a few rounds, the oil market perks up. Not today.

That doesn’t grab you? Well, US crude inventories have decreased by 6 million barrels this yea. That should have knocked oil prices up a notch.

And that is what makes this oil price move an example of trading flows. In this scenario, anything can happen. Speculation-driven moves are basically volatile, unpredictable, often wild, and without any apparent logic.

Except the logic of making profit of course! That’s why the technical analysis is more helpful than usual here. It maps out the playing field through the eyes of a trader. You can see what the pros see. So hurry up and take a look.

The first support traders will look at is around $121/122. That’s the first target.

The key moment in oil was when the price action crossed below that medium-term support line. It has been tested and validated several times (points A, B, C and D). The rally drove the prices from $85 to $148, a rise of 74% in 5 months and a half only. It’s perfectly understandable now that oil should fall just as quickly.

So we’re still about seven or eight bucks away from the part where the market finds strength. The other supports are around $111, $98, with a monster at $83. If support at $121 falls, we’ll let you know more about the others. That’s how oil is shaping up.

[Please note: neither the authors nor any of the employees of Port Phillip Publishing own shares in any of the stocks discussed in Money Morning. The articles do not give trading or personal investment advice, but are intended to provide a useful, independent news and analysis service to supplement your own investing and trading. Consult your financial advisor before making any investment decisions.]

Gabriel Andre
for The Daily Reckoning Australia

• S&P/ASX 200 Clears Resistance Line
• An Oil Price Correction is on the Horizon, When and Where
• Crude Oil Could Hit $200/Barrel
• How to Trade Gold Shares
• Crude Oil Becoming Much Harder to Find

The Dow is only 30 major companies. But in two important ways it shows that the U.S. model for prosperity over the last 50 years is in big trouble. While this certainly affects Australia, it is not entirely bad news.

The first blow to the U.S. model is the decline of General Motors (NYSE: GM), a company that is, in many ways, the epitome of the large, vertically integrated, post-World War Two major U.S. corporation. GM has made more money in recent years as a finance company than a car company. That's because it's hard to make money making cars when labour is so much cheaper over seas...and when you are selling massive cars at just the time petrol is getting more expensive.

It's hard to believe that it's impossible for GM to make money. Toyota makes money making cars and wages in Japan are higher than wages in Mexico or China. But GM has many legacy costs and is itself a house- divided, half-ageing industrial manufacturer and half modern finance company. Both are endangered species. That's why the stock fell to a 54-year low yesterday.

The other blow to the American model is seen in the 6% decline in Citigroup (NYSE: C) shares. Rome didn't fall in a day either. But Citigroup is now at a ten-year low, facing billions more in losses, and literally looking to recapitalize its business (and transfer ownership and future earnings) to Sovereign Wealth Funds from the Middle East.

To review: big American firms can't make money making things. Big American firms can't make money lending money. Those are two formidable challenges for the rest of the year. In fact, they are two big challenges, full stop. Industrial economy: splat. Financial economy: splat. What's left?

Of course there are some U.S. firms that can and will compete in the global economy. But what we're pointing out again is how competitive the world has become. Nobody ever got rich consuming more than producing. For investors, this means broadening your horizons to the many stocks listed all over the globe that are not correlated to the U.S. story...and that are making things.

Fortunately, Aussies have a lot to choose from. The downside is that a global slowdown hurts everyone. The upside is that the growth in industrial production in the developing world is a perfect fit for Aussie resource producers.

The risks? As one reader put in an e-mail this morning, maybe we aren't just facing Peak Oil or Peak Food or Peak Water, but Peak Man. That is, is it really possible that there are more people on this planet than its resources can support?

Our answer to that is no. But it's a long answer, so you'll have to wait for the rest of until Monday. As bad as the markets are, we suspect the sun will still come up tomorrow. Here's hoping...

Dan Denning
The Daily Reckoning Australia

• Is the Macquarie Model Dead?
• General Electric & Lift Capital Usher in Rough Start for ASX
• One Year Treasury Bills to be Reissued by Bush Administration
• CRB Commodities Index Has Largest Decline in 50 Years
• Citigroup, America’s Northern Rock