First, Goldman's buy on the banks seemed to buoy the market. The Dow finished up 112 points and is just under 9,600. Meanwhile, Aussie stocks shrugged off that sense of impending doom and rallied 43 points yesterday. The ASX 200 is at 4,622 and thoughts of 5,000 by the end of the year must surely be dancing like sugarplums in the heads of some investors.

Ho! Ho! Ho!

But seriously. The banks? Really? Aren't you the least bit suspicious that Goldman is talking up the banks? Doesn't this mean Goldman is probably already short on the banks?

We have been hanging out at what we now call the "Trading Nebula" in our new offices. Our research department is growing, so we like to drop by and see what the traders think is happening. Often, it seems nebulous to us, given the peculiar vocabulary of indicators and charts the guys are using. Hence the "Trading Nebula."

But Murray Dawes was especially clear this morning when he told us that his screens are producing all sorts of warning signals on the banks. He is obviously running a different trading algorithm than Goldman. But then, he's producing trading leads for our new Slipstream Trader, which is designed to produce long and short ideas on ASX 200 stocks. In our chat this morning he told me that two banks showed up, although neither were part of the big four.

If Murray is suspicious that the banks can lead the market to higher highs, at least he's in good company. Bear heroine and noted financial analyst Meredith Whitney wrote in the Wall Street Journal over the weekend that, "Anyone counting on a meaningful economic recovery will be greatly disappointed. How do I know? I follow credit, and credit is contracting."

You don't say?

"Access to credit is being denied at an accelerating pace," Whitney adds. "Large, well-capitalized companies have no problem finding credit. Small businesses, on the other hand, have never had a harder time getting a loan...In the U.S., small businesses employ 50 percent of the country's workforce and contribute 38 percent of GDP...Without access to credit, small businesses can't grow, can't hire, and too often end up going out of business."

What then, has the regulatory and policy reaction actually produced? It's propped up large institutions that still have heaps of bad assets and have used the last six months to increase their leverage. But at the regional and local level, real businesses with real customers and real capital needs can't get credit.

To summarise: We have saved the zombie companies with zombie assets at the expense of the living, breathing engine of the free market; the small business. This leads Whitney to conclude, that "We are only in the early stages of the second half of this credit cycle...I expect another $1.5 trillion of credit-card lines to be removed from the system by the end of 2010."

What will happen to the economy then? And what will happen to Australia then? Will it matter? The ability to extend credit to small businesses and households is concentrated in the hands of the Big Four. Does that make us safer? Or does it concentrate the risk in a few major players, jeopardising the whole system of credit?

What's clear is that the supply of commercial credit is more concentrated now than ever before. Will the Big Four shun risk and build a capital cushion by cutting off small business credit? Will they double down on their housing lending in order to support house prices; a scheme which supports the value of the assets the banks carry on their balance sheets?

If we're making it sound like the market and the economy are at a critical inflection point, it's because they are. The complacency of the last six months is giving way to some real questions about what to do with troubled assets that are still troubled and bad debts that are still bad. Can a global economy really grow when the financial system is weighed down by so much debt?

Professor Michael Hudson is coming to Australia and he says "No!" If you're interested in hearing what he has to say in person, check out his schedule here. You can RSVP for the event near you, provided seats are still available. If you can't make it, there's a good You Tube video of his ideas here.

We're not familiar with everything Dr. Hudson has to say. We're planning on catching up for lunch and will report back to you how it goes. In the meantime, he gave an interview with the folks over at Business Spectator and put his views lucidly: "There's a basic mathematical principle; a debt that can't be paid won't be paid."

Talking about the explosion in consumer debt world-wide, including here in Australia, Hudson says, "These debts are beyond people's ability to pay and so we're going to see breaks in the chain of payment and this means that a lot of debts are going to go bad. It means that people are going to hesitate to realise that they can't pay, a kind of cognitive diffidence [sic] that people have about the fact that they really can't pay their debts."

"They're willing to run down their savings, they're willing to sell off their assets and do everything, but in the end they default and this is what breaks the back of an economy. The houses are defaulted on, they're put up for sale, that crashes real estate prices all the more and, again, the commercial real estate is even in more serious condition than residential real estate right now."

Coming back to Barofsky and Goldman then, and if Hudson is right, is this the time to buy the banks? Barofsky's report concluded that not all nine of the banks that received $125 billion in capital infusions from the U.S. government here as "healthy" as Ben Bernanke and Hank Paulson made them out to be.

The nine institutions combined had over $11 trillion in assets. But Paulson made it sound as if the capital infusion would not only stabilise the banking sector, it would prompt the resumption of credit flows in the economy. That turned out to be...not true.

So what is the truth? Well, as we suggested at the time, the TARP was just a massive delaying tactic. The capital infusions (putting aside that it wasn't really capital but money the Federal government borrowed that must be repaid) were designed to prevent the banks from going insolvent on further asset write downs. But the whole logic of the deal was that asset values would stabilise and even improve, meaning the banks wouldn't have to take losses or raise more capital.

Give it time baby. Time heals all asset values, right?

No. It all goes back to what you mean by "troubled." And this is the real heart of the issue behind our mistrust of the stock market rally. There has been no real improvement in the quality of troubled assets in the last year. In fact, they are more troubled than ever. The financial system remains troubled, and not much in it has really changed.

This leaves the highly-leveraged banks in the same precarious position as they were before, albeit with slightly more confidence from a gullible public. But at the balance sheet level, have things really improved? And more importantly, have the trillions in assets in the financial system related to residential and commercial real estate really become more valuable in the last six months? Or is just a Ponzi Finance pyramid of junk waiting to go up in flames?

In our view, the last year has been a policy and regulatory sham to cover the retreat by bankers. The people heavily invested in the old system of debt-based asset appreciation are stalling for time. They hope that the passage of time will improve earnings for a quarter for two.

And if they are the religious sort, they pray that some other scheme will be established to take the troubled assets of their hands. But time cannot heal troubled asset values. Faith healing doesn't work in financial markets. We'd humbly suggest that the day of reckoning is still out there, hiding somewhere on the calendar, waiting to rise again. Until then...

Dan Denning
for The Daily Reckoning Australia

• Normally Small Businesses Lead the Economy Out of Recession
• Meredith Whitney and the Buy Recommendation on Goldman Sachs
• Rising in Defense of Goldman Sachs
• Warren Buffett is Buying Four Percent of Goldman Sachs
• Is the Macquarie Model Dead?

And now back to the financial markets....

Go you little Aussie mortgage bubble! The value of new mortgages grew in May by 2.2%, according to the Australian Bureau of Statistics. For the month, investors boosted their demand for new mortgages at a faster clip than people who intend to live in the house (owner occupiers). That doesn't sound like a bubble at all does it?

Two other items of note in yesterday's housing numbers. The First Home Buyer's consolidated their position as the most important group propping up Australian house prices. First home buyers increased their percentage of total owner-occupied mortgage demand from 28.6% in April to 29.5% in May. Nearly a third of all demand for new mortgages is coming from new buyers sucked in by the grant. Hmmn.

One final note. The average loan size for the first home buyer was $281,000. That was actually a $3,400 fall from the month before. But it's still $14,400 higher-or about 5%--than what the average loan size of all the other borrowers in May ($266,900). Max out your borrowing at the low point of the interest rate cycle. Hmmn.

Moody's economist Matt Robinson told a reporter that, "The policy stimulus from the Federal Government and the central bank has helped boost the housing market, offsetting the deterioration in the labour market conditions that would otherwise subdue the willingness of people to purchase houses...This is a 'prime example'' of monetary and fiscal policy working."

That statement seems like a 'prime example' of getting the analysis absolutely wrong. We'll explain why in a moment. But first, a word about abductions.

What the heck is going on in Shanghai? Chinese police have detained Rio Tinto iron ore executive Stern Hu on suspicion of "espionage and stealing state secrets," according to Bloomberg. Hu hasn't been charged with a crime yet. Three other Rio workers who are also Chinese nationals are being held.

Incidentally, the Age's Matthew Murphy is reporting that Chinese steelmakers have agreed to a 33% cut in iron ore fine prices and 44% for lumps. "The deal would break a tense nine months of negotiations between the Australians and the Chinese, which had allowed the June 30 deadline to pass while refusing to budge on their demand for a price cut of up to 45 per cent," Murphy says.

Let's recap. In late March, Treasurer Wayne Swan knocked back China Minmetals' bid for 100% of Oz Minerals based on the proximity of Oz's Prominent Hill gold and copper mine to the Woomera weapons testing range in South Australia. Then in early June, Rio Tinto abandoned its offer to sell an 18% equity stake to Chinalco and instead raised the money from shareholders and a joint venture with BHP Billiton. And finally, the Aussie ore producers refused to give Chinese steel makers a larger discount this year than customers in Korea and Japan got.

So perhaps there's some hardball going on now? There are more than just business interests at stake in the relationship between Australia and China. There is national interest too. Interesting times, eh?

Let's quickly get back to that nonsense from the Moody's economist about policy stimulus 'working' by supporting the housing market. It could be a simple case of diagnostic failure. He said the policies are, "offsetting the deterioration in the labour market conditions that would otherwise subdue the willingness of people to purchase houses." But is this true? And if so, is it something to celebrate?

First off, throwing money at people to buy a house when they are at risk of losing their job doesn't seem like a good policy at all. It seems reckless. It also seems like the height of stupidity. But the larger issue is whether you can correct a problem if you don't really understand its causes.

The correct answer would be, "no." The policy responses inspired by John Maynard Keynes call for the government to run a deficit and spend money that households and businesses will not. But this response assumes that aggregate demand (household and business spending) has fallen for no good reason at all and that all the government has to do is restore confidence (by stimulating the appearance of health) and everything will be fine.

Balderdash! The problem isn't that demand has fallen unreasonably. It's that credit rose too much. The economy needs to walk itself back to more production (creating value) and less credit-financed consumption. Recessions aren't caused by too little spending. They're caused by spending gone wrong in a credit boom (mis-allocated capital).

In his latest Gloom, Boom, and Doom Report Dr. Marc Faber says, "This is where I have the greatest problem with US economic policy makers [ed note. We'd add Australian policy makers to the mix]. I don't think they have ever recognised that the excessive, credit-driven expansion of the US economy was unsustainable in the long run and that, sooner or later, the current crisis was inevitable. But not only that!"

"Now that we all know that the monetary policies implemented after the Nasdaq bubble burst in 2000 led to the current crisis, US economic policy makers are attempting to restore economic growth through essentially the same policies; the difference, this time, being that gigantic fiscal deficits are also being created."

To be fair, not ALL Aussie policy makers are making the same mistakes. As we reported yesterday, Glenn Stevens seems to know that in a balance sheet recession, the way back to recovery is to patiently rebuild the balance sheet on a foundation of solid assets and reduced debt. That's the course he encouraged businesses to take.

It's Australia's government that has us worried, and it's both parties frankly. The worse the recession gets (it IS a recession and it will probably get worse, we reckon) the more tempted (and forced) the government of the day will be to borrow more and more and run the deficit higher and higher. This won't be good for confidence in Aussie assets.

Speaking of which, Faber also had something to say about the on-going feud between inflation and deflation. "Asset markets," he wrote "are buffeted by recurring waves of inflationary and deflationary expectations and I'm afraid we might now run again into a bout of deflationary fears. But unlike the deflationists, I don't expect new interest rate lows in this cycle."

"The interesting part about all this is how the various asset classes relate to each other. Equities and commodities seem to move up at the same time (driven by rising inflationary expectations and growth expectations), while bonds and the US dollar move down (the pattern since March 2009). But, when deflationary expectations increase, the US dollar and bonds strengthen while commodities and stocks decline (the patter of 2008)."

If Faber right and the deflationistas have the upper psychological hand, bond prices and the U.S. dollar go up and stocks and commodities will go down. For Australia, you'd probably see a weaker Aussie dollar versus the greenback and lower stock prices too. Meanwhile, the government will try to restore growth by running large fiscal deficits which may stabilise the economy a bit, but a lower level of output (as businesses stay on the sidelines with investment spending).

So how much lower could stocks go? Faber thinks it will be a few years before stocks make new lows (below the 2003 levels, we assume). He says stocks were oversold in March but overbought in June. Stocks are now priced for an economic recovery that looks increasingly illusory.

Two other things from the good Doctor. He expects to see rebounding corporate profits as businesses begin to reap the earnings benefits of cost-cutting and deleveraging. They will be coming off a low base anyway. So he may be right to consider the dismal upcoming profit season as a contrarian nadir.

The other interesting observation is that there is still a large cash position in the market. In fact, according to The Bank Credit Analyst, cash as a percentage of the Wilshire 5000 (the broadest index of U.S. stocks) is at its highest level ever. It's a veritable mountain of cash.

If we've done our maths correctly and the Wilshire has a total market capitalisation of nearly US$9 trillion, that means there's about $8 trillion in cash, money market funds, and savings waiting to hit the road. Where will it go?

It doesn't look like investors are buying the "green shoots" line being peddled by Ben Bernanke. That means the cash may not be going anywhere. Or-again using the Faber thesis-it could go into U.S. bonds. Faber also says that on a price-to-book basis emerging market stocks look a lot more attractive than U.S. stocks.

We reckon U.S. investors are still scorched from the last two years and would be reluctant to get back into the market with authority via emerging market stocks. That alone might make emerging market stocks good value for money. It doesn't really tell us where all the cash might go, though, does it? We can think of a few places and will have more to say about it tomorrow. Until then!

Dan Denning
for The Daily Reckoning Australia

• Wage Pressure in China to Drive Up Cost of Goods in Australia
• China Fueling Inflation in Australia & New Zealand
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• The Bubble Deniers Deny that Their Own Stimulus Caused it
• AUD Price of Gold a Measure of Gold’s Strength Against Other Currencies

But this is a stock market rally you must handle with care. Last week's close on the Dow saw that psychologically important index erase its losses for the year. After being down as much as 25% in mid-March, the Dow-led last week by soaring energy stocks-has lifted into the black again. So where to now?

Well, confidence cannot repair a balance sheet. Only reducing debt over time can do that. But there is a whole raft of data this week that will tell us if the economy truly has turned the corner. We reckon it has, but that there's another sharper corner ahead. Buckle up. And maybe slow down.

In the U.S., manufacturing data comes out this week. Industrial production in the world's largest economy has fallen sixteen out of the last seventeen months. Many economists will tell you it can't get worse. Unless, that is, the U.S. (like a lot of the Western world) is in a long decline in which the entire economy becomes less productive. If that'd the case, what difference does a month make?

For financial markets-especially credit markets-the bigger number will probably be U.S. housing starts. For some odd reason, there are a lot of people who think builders are going to start building again even though U.S. housing inventories are ample (and mortgage rates are rising, reducing demand anyway.)

But it's a wacky world out there. For instance, the Commonwealth Bank raised the interest rate on its variable rate mortgage loans over the weekend 5.74%. It says it may raise its fixed rate too. And other banks may well follow. This is probably not what the government expected when it engineered a 0.5% increase in first quarter GDP.

However there's a growing gap between the RBA's cash rate of 3% and what Aussie banks are paying to borrow in the whole sale market. In other words, whether its inflation fears or anticipating a recovery, interest rates are moving up. The banks are simply adjusting to what the futures markets are already predicting.

This unwelcome development for housing finance makes tomorrow's release of the notes from the last RBA morning that much more interesting. If the RBA doesn't show an easing bias-if instead it confirms the inflation fears-it's going to be hard to blame the banks for hiking up rates now (even though unemployment is still rising and the rate rises are especially bad for the Aussie housing market).

When you add it all up-just the appearances and hunches and sentiment-we get the feeling that the momentum in stocks may carry indexes higher by another 3-5%, and then a correction. If you're sitting on gains from the last few months, you may want to pay special attention to the analysis below from Swarm Trader Gabriel Andre.

In a Friday update, the Swarm Trader showed in a chart what we'd only suspected. Namely, to be on the watch for a correction. "There is very little doubt," he wrote to subscribers, "that the Index will reach the level of 4,200 points soon, probably next week. This target is just a bit more than 3% higher than today's closing price. Because of the technical resistance (valid since November 2007) and because of overbought indicators, a correction is likely to quickly follow. In a first time, the level of 3,900 points may be the first intermediary support."

Technical Resistance on the ASX/200 at 4,200

Click to Enlarge

What happens after that? Who knows? We'll keep you posted on Gabriel's research. He's lately been applying it to finding entry and exit points for stocks listed on the ASX/200. Meanwhile, his technical indicators continue to producer shorter-term trading opportunities as well. He's a busy man.

Did we really mean to say the government is trying to steal your superannuation savings by making a deal with the fund industry? Well, sort of. Super assets represent a huge pool of capital that manages to generate fee income for an entire industry. The government also sees that money as a source of funding for its infrastructure and other plans.

It's important to remember that Super is a tax scheme too. Even though the contributions are compulsory, you don't have to channel it all into stocks. In fact, based on some of the long-term trends we profiled last week, we think investors will have to start thinking about other ways to make, grow, and keep income in the coming years. The stock market will not be enough.

We asked Kris Sayce-who's been leading up the research into more income and safety in your super-what he thought of last' week's news. His reply is below. Stay tuned for more on this subject in the coming weeks.

Kris writes that, "There will be a new 'Super Govt Aged Pension' that will allow you to give-up your existing super balance in return for defined benefit based on the existing balance plus any future super contributions you make. You'll still pay the 9% super guarantee except it will have to go to a special government fund - perhaps they could call it the Future Fund... except that name's already taken!

"The other level will be to make the 'default' funds for fund managers one which includes 'infrastructure' funds. This would be easy as all funds have a range of minimum and maximum levels for specific investments. Another way will be to increase the super guarantee from 9% to 15%... the unions and super industry are in favour of this, plus it wouldn't be a tough sell to the electorate as very few people consider this as being a tax, which it would become, even more of as your ability to have control over your super is diminished.

Hmm. Higher compulsory contributions with less control of your money. Sounds like something you'd want to avoid or at least plan for, doesn't it?

"Finally," writes Kris, "the tax and regulatory rules for SMSF will be made so onerous that it will be unattractive for people to open an SMSF. I read something recently that stated SMSF investors needed more 'education' on how to run their fund, etc... In other words it will mean increased costs for accounting, auditing, training, reporting, and legal.

"Before and after these changes I expect an increase in the number of audits by the ATO on SMSF that will comprise a scare campaign -'Look at these investors, they've been fined $X for not do this, or they've gone to jail for doing that - do you really want to risk it? Why not take out a Super Govt Aged Pension instead?' There will be very little resistance to these changes especially now when the market is low and when the public is becoming more and more indoctrinated into receiving government support!"

O brave new world with such wealth-stealing in it. What should an investor or a free man do? More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Superannuation Raiding Party Being Formed
• Your Average Australian Super Fund
• Is Kevin Rudd Planning to Steal Your Superannuation and Bankrupt Your Retirement?
• Actively Managed Superannuation Funds Have Not Had a Stellar Few Years
• World of Super Collides With World of Credit Crunch

The attendees come for a number of different reasons. Some want to gain some insights on interest rates, the dollar, or the stock market. Others are seeking a new investment strategy. Still others are looking for good investment ideas or, as one gentleman insisted, "just one great stock."

But before you can put your money to work effectively, you need something even more fundamental to your success: a philosophy of investing.

In her book Philosophy: Who Needs It, Ayn Rand argues that all of us have a philosophy of life, whether we know it or not. "Your only choice," she writes, "is whether you define your philosophy by a conscious, rational, disciplined process of thought...or let your subconscious accumulate a junk heap of unwarranted conclusions..."

What's true of life is also true of investing.

Over the past two decades, I've dealt with thousands of individual investors, some highly astute, some rank novices. Many had only the foggiest notion of what they were trying to achieve - or how. In some ways this is understandable. World financial markets are complex and the investment process can be daunting.

Beginners often don't understand the fundamentals of saving and investing. And even more experienced investors are often stymied by the complexities and technical jargon surrounding the investment process. Many try (and inevitably fail) to outguess the markets - or simply wave the white flag and turn their portfolio over to "that nice young man down at Merrill Lynch."

Big mistake.

No one cares more about your money than you do. With a basic understanding of the investment process and a bit of discipline, you're perfectly capable of managing your own money, even your "serious money." Especially your serious money. By managing your own money, you'll be able to earn higher returns and save many thousands of dollars in investment costs over your lifetime.

The Gone Fishin' Portfolio rests on a powerful philosophy of investing. It's battle-tested. It's built on the most advanced - and realistic - theories of money management. And it works.

Moreover, The Gone Fishin' Portfolio does something that virtually no other investment guide does. I'm going to show you - very specifically - where you should put your money. And then I'm going to show you how to manage it year after year.

Once you've set up your portfolio, the whole process will take less than 20 minutes a year to implement. This may sound like an audacious claim. But, as you'll soon see, the strategy itself is steeped in humility.

It is based on the only realistic premise for an investment philosophy - that, to a great extent, the future is unknowable. So don't expect me to draw on my gift of prophecy and tell you what's going to happen to the economy, interest rates, the dollar, or world stock markets. (No one is more surprised than me how the market action unfolds each year.) Nor will we ignore uncertainty or pretend we have a system that has eliminated it. Instead, we're going to use uncertainty and make it our friend. In short, we're going to capitalize on it.

Investing is serious business. Getting it right is the difference between a retirement spent in comfort (or luxury) and spending your golden years counting nickels, worrying whether you'll have enough. The difference could hardly be starker.

Up until now, you may have been tempted to turn your investment portfolio over to someone else to manage. After all, your financial security is paramount. You may not think you can take the risk - or handle the responsibility - of running your money yourself. I fully intend to disabuse you of that notion. I also want to point out that there are serious risks to turning your money over to someone else. That person may manage it poorly. Or be terribly expensive. Or both.

If you're skeptical on this point, it may be that you've bought the story that Wall Street is selling: Investing is so complicated - or your personal circumstances so exceptional - that you should not be trusted to run your own money.

I'll concede that if you don't know what the heck you're doing, this is absolutely true. But one solution is learning what to do, rather than turning your financial welfare over to someone else.

When it comes to managing your money, there are plenty of potential pitfalls out there. However, those investors who wind up in retirement with less money than they need have generally fallen prey to one of four basic mistakes:

1. They were too conservative, so their portfolio didn't grow enough to begin generating the income required to meet their spending requirements.

2. They were too aggressive, so a significant percentage of their portfolio went up in flames along the way.

3. They tried - and failed - to time the market. Confident that they would be in for market rallies and out for market corrections, they ended up doing just the opposite much of the time.

4. They delegated unwisely. They turned their financial affairs over to a broker, insurance agent, or financial planner who - over time - converted a substantial amount of their assets into his assets. In addition, the advisor may have been too conservative, too aggressive, or tried and failed to time the market.

If your nest egg is lying in pieces late in life, you generally don't have the opportunity - or the time - to build another one. The consequences, both personal and financial, can be devastating.

Planning your financial future is a momentous responsibility. Although The Gone Fishin' Portfolio has a lighthearted name, it enables you to handle your serious money - the money you need to live on in retirement - in a serious way.

There are few guarantees in the world of investing. In fact, once you get beyond the risk-free world of Treasuries and certificates of deposit, there are virtually none. However, The Gone Fishin' Portfolio eliminates six major investment risks:

1. It keeps you from being so conservative that your long-term purchasing power fails to keep up with inflation.

2. It prevents you from handling your money recklessly.

3. It does not require you to own any individual stocks or bonds. So a single security - think Worldcom or Enron - cannot cause your portfolio to crater.

4. It does not require a broker, financial consultant, or anyone else to attach himself to your portfolio like a barnacle, siphoning off fees every year.

5. It doesn't require you - or any investment "expert" - to forecast the economy, predict the market, or analyze competing economic theories about the future.

6. Perhaps most importantly, it guarantees that your time will be your own. Rather than spending countless hours evaluating stocks, market trends, or fund managers, you'll spend your time as you please. While others struggle to manage their money effectively, you'll have "gone fishin'."

This last point means that instead of spending countless hours fretting over your investment portfolio, you'll be able to relax...play golf...travel the world...spend more time with your kids or grandkids...or just swing on a hammock in the shade with a glass of ice-cold lemonade. Because your investments will be on autopilot.

This is not just a strategy for today's markets, incidentally. The Gone Fishin' Portfolio is designed to prosper - and generate peace of mind - through all market environments.

And I invite you to be skeptical. In fact, let me begin by asking you a question:

If I could show you a way to manage your money yourself, using a strategy that is as powerful and effective as any used by the nation's top institutions, that will allow you to outperform the vast majority of investment professionals, pay nothing in sales charges, brokerage fees, or commissions, that will take less than 20 minutes a year to implement, and is based on an investment strategy so sophisticated it won the Nobel Prize in economics, would you be interested?

I hope so. That, in a nutshell, is The Gone Fishin' Portfolio. It's about handling the money you intend to retire on simply, effectively and cost-efficiently, with the absolute minimum of time and attention.

If you're like most people I know, you have better things to do than watch your stocks bounce up and down all day.

Don't get me wrong. I'm not averse to trading stocks, myself. (Long- term investing and short-term trading are not mutually exclusive.) But short-term trading strategies are beyond the scope of this book. Instead of focusing on trading or speculating, we're going to focus here on the money you intend to retire on - and perhaps ultimately leave to your kids, your grandkids, or your favorite charity. This is money that shouldn't be treated like chips in a poker game.

Reaching financial independence is a serious goal, one that should be pursued in a disciplined, rigorous way.

That's why I recommend that you make The Gone Fishin' Portfolio the core of your long-term investment program. The philosophy behind it is based on the best investment thinking available. It has been tested in various economic conditions. It increases your returns while reducing your risk. And it minimizes your investment costs and annual capital gains taxes.

Best of all, it works. Investors who have put their money to work this way have enjoyed years of market-beating returns while taking less risk than being fully invested in stocks.

Now it's your turn.

Regards,

Alexander Green
for The Daily Reckoning Australia

• Gone Fishin’ Investment Strategy
• The Problem With a Well-Diversified Portfolio
• 4 Ways to Protect Against a Falling Dollar
• Discussing the Dreaded Fibonacci Retracement
• The Inevitable Path Toward Capital Controls in America

A report on U.S. payrolls showed that the American economy shed around 491,000 jobs last month. This was less than expected by forecasters and the least amount of jobs lost in the U.S. since October of last year. So in a manner of speaking, losing half a million jobs in a month is an improvement.

Financial markets were encouraged by this news. In fact everything seems to be encouraged. The Dow was up. The S&P was up. Gold was up. Oil was up. Up, up and away!

Not even the news that Bank of America may require US$34 billion in new capital could bring the mood on the Street down. The results of the 'stress tests' have been duly leaked so the market can digest the rumour (and sell the news). The good news is that Morgan Stanley, JP Morgan, Goldman Sachs, and American Express all seem to have 'passed' the test and do not require additional capital (at least according to government accounting). Of the 19 backs quizzed, it looks like 10 will need more capital and 9 will not.

Whether the 'stress tests' really tell the truth about the banks or not doesn't seem to matter at the moment. There has been a huge cloud of uncertainty hanging over the banks (and thus the market) regarding their solvency. Just the idea that the cloud may be dissipated (and that the economy is free to recover) is sending stocks higher.

Don't take our word for it. Look at the Aussie dollar. Look at commodity prices. As we said yesterday, risk is back. If we get a resumption of the carry trade (borrowing in USD and Yen to buy higher yielding assets) it can only be good news for Aussie stocks. We just don't know how long the party will last.

Of course no one really knows how much capital the banks will need over the coming years to offset losses. It could be a lot more. U.S. real estate site Zillow.com says that 22% of Americans owe more on their homes than their homes are worth. That's what we call "negative equity." If it were true, it would mean more than 20 million homes are underwater.

Do you think the stress test included the possibility that 20 million Americans would default on their mortgages? Probably not. It's an almost apocalyptic number. But it IS a credit depression. And it WAS a pretty big bubble in housing.

Here in Australia, everyone's going berserk spending government money. Retail sales hit $19.3 billion in March. That was a 2.2% gain over February. Nothing like a little national retail therapy to deal with a structural problem in the economy, is there?

That structural problem-similar to America-is an economy built on consumption and housing and the financial industry. That said, this looks like a rally you don't want to get in the way of.

Even Rupert Murdoch thinks "the worst is over." "There are emerging signs in some of our businesses that the days of precipitous decline are done and that revenues are beginning to look healthier," he said, after saying that he expects the full year operating profit to be 30% lower than last year's figure.

He also said he believed advertising dollars are fleeing print newspapers for good, to the web. And it's worth noting that one of Murdoch's properties-the Wall Street Journal-is one of the few newspapers that charges for online content. It's not a coincidence that the Journal is one of the few profitable papers in the U.S. Its circulation is rising.

Hmm. Charging for on-line content. It's a thought.

Until tomorrow...

Dan Denning
for The Daily Reckoning Australia

• Bank Stress Test Not Stressful Enough
• Were the Government’s Stress Tests a Bogus Exercise in Deception?
• Australia to Borrow as Much as $300 billion
• House Prices Down and Aussie Market Enters Second Wave of Rebound Rally
• Fannie and Freddie Say Goodbye to Veto

We'll take both. The panic in financial markets subsided in March and stocks rallied. Stocks didn't make new lows on bad news and the bad news (as bad it was) ceased to get more bad, which was good.

But what about Main Street, what's going on there? According to the Westpac-Melbourne Institute consumer index released yesterday, Australians were exactly 8.3% more confident in early April than they were in April March. See what a dose of low petrol prices, declining interest rates, and government cash can do for you?

We were searching for all sorts of entertaining metaphors to explain this, but the simplest explanation is good enough: be very afraid. The government has done its part to disarm people's natural sense of caution by showering them with cash. But there is plenty to be afraid of, and plenty to suggest these confidence numbers will plummet in a few months.

The trouble is, all the other indicators in the real economy suggest that Main Street is going to get flogged later this year, mostly by rising unemployment. There's also the possibility, which we discuss below, that a second round of real panic will hit financial markets when the Geithner plan fails to solve the toxic asset problem. And then you will have duelling panics in the corridors of power finance and in kitchens all over Australia.

If there is a recession out there in Australia, though, no one is telling first home buyers. With their pockets stuffed with wads of government cash, the FHB's continued to single-handedly prop up Australian property prices, according to data released yesterday by the Australian Bureau of Statistics. Ah...the strength and vigour of youth.

The amount of money committed to housing rose 1.3% in seasonally adjusted terms, from $18.9 billion in January to $19.2 billion in February. You can credit that rise to the FHBs. Their share of the market for new commitments to owner-occupied housing grew from 26.5% in January to 26.9% in February.

Remember, in January of '08-before the increase in the Federal FBH grant-new first home buyers made up just 12.1% of the housing finance commitments. Their contribution to the money flowing into the housing market has grown 122% since then. But will they get what they paid (borrowed for)?

We continue to believe that you are seeing the blow-off phase of Australia's property bubble. It's one of the last remaining housing bubbles in the world yet to pop. But the introduction of the FHBs into the market as a key support of property prices is a sign that it may be near its peak. And that is not good news for the FHBs.

The ABS reports that the FHBs are paying nearly 11% more for their new homes than other owner occupiers. According to the data, the average loan size for FHBs grew by six percent from January to February, from $264,500 to $280,600. Meanwhile, for everyone else in the market, loan sizes fell slightly, from $255,900 to $253,200.

Do you think mortgage brokers and lenders are giving the FHBs larger loans out of the kindness of their hearts? Or do you think the $27,000 difference between loan sizes has something to do with sellers and real estate agents squeezing as much of that FHB grant into their pocket as possible? Hmm

Meanwhile trouble is brewing again in the financial markets. As we mentioned yesterday, the IMF is predicting another $3.1 trillion in toxic bank assets. And there is growing scepticism in Washington that the Treasury Department knows what it's doing.

A report released yesterday by the panel in charge of overseeing the deployment of the TARP raised the possibility that the Treasury is making a basic assumption in its handling of the crisis, namely that impaired assets will recover.

The report, which you can read here if you like, said "It is possible that Treasury's approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability."

The report then went on to suggest what those "very different actions" might be. They include three main options: liquidation, receivership, and subsidisation. Since the first two options entail admitting failure (and watching several large U.S. banks go down, which could take down other banks and institutions as well) the third option is walking down TARP lane on the road to subsidisation (PPIP).

But that's not so flash either, according to the report's authors. They first describe how it's worked so far and that what might not work later. "Subsidies may be direct," reads the report, "by providing banks with capital infusions, or indirect, by purchasing troubled assets at inflated prices or reducing prudential standards. Cash assistance can provide banks with bridge capital necessary to survive in tough economic times until growth begins again."

"But subsidies carry a risk of obscuring true valuations. They involve the added danger of distorting both specific markets and the larger economy. Subsidization also carries a risk that it will be open-ended, propping up insolvent banks for an extended period and delaying economic recovery."

Subsidies also create zombie banks, a zombie economy, and a really angry populace that realises one industry and its legacy of mistakes are being propped up by its political supporters in the corrupt capital. It spells trouble.

"Dude, are you depressed?"

"No," we answered. "But I will have another beer."

"I mean everyday its 'toxic assets this' and 'great depression' that and 'gold, gold, gold. If all I did was read your stuff, I'd think the financial world was coming to an end."

"It is, at least the financial world as you know it. And I know you read other stuff. That's why I write what I write."

"What do you mean?"

"Well, if all I did was tell everyone what they already knew, or just summarise the news, who would bother to read it?"

"No one, except maybe your mother."

"Maybe. But the point is, there is serious stuff happening out there. It started in 2007. There are a lot of people who want you to believe that the worst is over. Maybe they want to believe it themselves. But I think you should at least be prepared for the possibility that it's not."

"Doesn't look to me like you're doing much preparing. A lot of repeating maybe. Definitely a lot of writing. But preparing?"

"Well you're a moron. The first thing you need to reconsider is whether or not now is a good time to buy into a rally. It's not. Next you need to re-think your basic asset allocation. And you should probably rethink your basic assumptions about retirement income...your pension...the purchasing power of your savings, things like that."

"Whatever. These things go in cycles. They'll get better someday soon. Cheer up. Besides, who has time to worry so much?"

"I do. And so do people who have money and care about keeping it over the next five years when all the stuff I'm writing about goes down."

"Hey I'm a little short. Can you buy me another round?"

Dan Denning
for The Daily Reckoning Australia

• Building a Financial Panic Room
• The Achilles’ Heel of the Entire World Financial System
• Financial Crises in History
• U.S. Stocks Hammered to Dust
• Credit Markets Threaten Retail Banking, Bank Runs Next?

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

That theme will be popular for a simple reason. The global economy is awful. If you're looking for a justification to get back into shares at these levels, you have to convince yourself that the financial markets have bottomed out, even as the bottom falls out of the real economy.

It's a risk. But hey, 2008 was the year risk was re-priced. Capital, once abundant, is now scarce. And even so-called "safe" investments like U.S. Treasury bonds are no sure bet.

However you can't ignore the action in the market. Since falling to 7,550 in November, the Dow is up nearly 20%. Friday's 258 point rise sent the index up three percent on the day and above 9,000 again. It gives the Aussie market a positive lead into the week.

But beyond sentiment, it is hard to find much in the way of positive economic news. The double helix of the global economy-U.S. consumption and Chinese production-is coming completely unravelled. To the extent that the entire dynamic was a product of cheap money and global imbalances, you wouldn't expect it to survive a contraction in global credit. But its collapse is pretty breathtaking.

The retail collapse in the U.S. continues. It's Armageddon for the sellers of stuff. Bloomberg reports that, "The International Council of Shopping Centres in New York predicts 73,000 U.S. stores may shut in the first half of 2009 after what may have been the worst holiday-shopping season in 40 years."

Your editor strolled though a massive retail space in Colorado last week, the Flatirons crossing mall. One thing you notice right away is the number of vacant store fronts. The other is the massive discounting going as retailers try something, anything too boost sales. It's too late for many of them. Over 148,000 stores shut their doors last year.

With U.S. consumer demand collapsing, the number of Chinese factories cranking out "stuff" is set to decline as well. "Trade finance is collapsing," Victor Fung tells the International Herald Tribune. Fund is the chairman of the Li & Fung Group, a supply chain management company that connects factories in China with retailers in the United States and Europe.

Fung says, "We've got orders we can't ship right now." He estimates that 10,000 of the 60,000 factories in China owned by Hong Kong interests have closed or will close in the coming months. "China's manufacturing shrank for a third month in December as export demand fell, suggesting an economic slump is worsening despite government efforts to shield the country from global turmoil," reports the West Australian Business News.

The Chinese and American governments have both rolled out their own respective plans to "deal" with the crisis and stimulate the economy. But you begin to get the feeling this economic relationship has reached the end of its useful life. But what will it mean for stock markets?

And more questions. What will it mean if China no longer racks up large trade surpluses because U.S. consumers have gone into their shell? Without trade profits to recycle back into American capital markets, will interest rates on U.S. government debt rise in 2009? And what does all this mean for Australia's resource-reliant economy?

Jeez. That's a lot of questions to begin the New Year with.

Answers?

Your editor admits his brain is a little scorched after enjoying the spectacular weather yesterday in Melbourne. But here is the beginning of an answer...the U.S.-China relationship that drove most of the global growth in the last ten year is dead. This does not mean that the U.S. and China will now become economic foes.

But it does mean that the relationship simply can't survive a world where consumption is no longer financed with credit. China's growth is going to have to become less U.S. centric and more organic. Whether or not that is really possible is another question.

For 2009, however, we'd expect to see the model fall apart even more than it did in 2009. That is, the destruction of leverage in the financial markets will have more real world consequences. Factories will close. People will be fired. For commodities, non-competitive producers and many explorers are already facing extinction. You can expect to see more culling this year.

As far as financial markets have already fallen, it's hard to see them rallying strongly for the year when the global economy is weak (and getting weaker). Thus this year looks like a period of consolidation. The scale of economic activity will contract. Real economic growth in China, India, and the developing world will be delayed by the final acts of the credit crisis.

In the meantime, investors are going to have to deal with the huge increase in the amount of borrowing by the U.S government. The supply of sovereign debt is increasing. The world's stock of real available capital is not. This argues for gold in 2009.

But what about the private sector? Government borrowing is going to crowd out private borrowing. It's not clear, for investors, which industries will benefit from all that new government borrowing and spending, or whether that's even an investable idea. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• The Codependent Relationship Between China and the United States
• China is the World’s Largest Exporter to the Middle East
• Were Chinalco’s Intentions With Rio Always Honourable?
• Chinese Economy Seems to be Growing
• The Collapse of Complex Asset Values

Asciano has $4 billion debt on the books (much of it inherited from when the company was spun from Toll in 2007). But yesterday the company assured investors it wouldn’t be beefing up the equity on the balance sheet with another dilutive capital raising. And chairman Tim Poole told investors earnings were in line with forecasts.

The trouble is that with all that debt and, shall we say, challenging business conditions, investors aren’t convinced the equity in the company is worth anything anymore. This explains why the Citigroup analyst suddenly shifted from a discounted cash flow model of valuation (which focuses on the present value of future earnings) to an enterprise value model.

An enterprise value model adds up the market cap and debt a company has, and then subtracts cash and cash equivalents. It’s not quite the liquidation value of a firm. But it IS, generally, what it would cost you to take over the company and its liabilities, minus its cash.

So why switch valuation models in mid stream? Well, one reason is that you’re looking for any reason at all to get out of a stock, and one valuation model suggests a much lower share price than another, so you use it. But let’s assume the switch in valuation models is based on new and different business assumptions. What are those assumptions?

Well, if you’re taking your eye off earnings two and three years down the track, it means you think there are much larger immediate business concerns that affect the value of the firm. One of those might be access to capital. If a firm like Asicano has to rebuild its balance sheet by raising new capital on the equity markets, that dilutes existing shareholders.

But really, using an enterprise value model as the justification for selling a share means, as an analyst, you’re throwing in the towel on the business itself (not just the management or the balance sheet). It means you think being in the ports and rail business during a contraction in global trade is a lousy business, with zero earnings power going forward. The fact that Asciano has so much debt during a credit crunch certainly doesn’t help.

The challenge for resource investors now is to sort out which model to use for valuing over sold shares. For most resource companies (the non producers anyway) discounted cash flow models are pretty useless. The earnings are highly variable and cyclical for resource shares because commodity prices themselves shift.

Changing commodity prices affect the ebb and flow between supply and demand. If you asked us, we’d say low commodity prices are already leading to a tightening in supply. In addition to BHP, Rio, and Fortescue idling expansion and production plans in the Pilbara, Alcoa has shelved its expansion plans for its alumina refinery south of Perth. High-cost producers are already being forced out as well. What does all that mean?

It means the credit crisis and the deleveraging in the commodity markets in 2008 are going to lead to lower supply of key commodities in 2009. That lower supply, so far, looks like it will be enough to meet the lower demand that’s been brought about by the global recession/depression.

But it also leaves the surviving players in the resource patch in an enviable position. They tend to have cash. They tend to have lower debt/equity ratios. They tend to have better projects where ore grades are higher and costs of production are lower. And the really good ones have poly-metallic ore bodies, a sort of geological diversification that allows them to shift production to those metals with the highest current market prices, while leaving the other stuff in the ground for a rainy day.

The one-trick ponies (those without a poly metallic deposit) are in a tougher spot. But if you believe China’s stimulus package announcement marks the long-sought shift in the Chinese economy away from exports and towards domestic consumption, well then it’s not all bad news for the smaller Aussie resource juniors. More on that tomorrow.

Outside the Lucky Country, General Motors (GM) is telling anyone who will listen that if it doesn’t get a bailout before Christmas, it may not survive to see Barrack Obama inaugurated as the 44th President of the United States on January 20th. GM shares closed under $3 for the first time since 1946. At $2.92, it was a 65-year low for America’s big auto-maker.

Some of Australia’s new handout to automakers will probably make it back to GM and Ford’s Detroit coffers. But if the companies are going to survive in their current form, it will take a mighty Federal hand out to make it happen. And hey, everyone is getting one of those these days. So why not?

It is a remarkable thing that the icon of America’s industrial manufacturing might is on the verge of recognising its bankruptcy. In some ways, GM’s downfall reflects the conscious decision of American policy makers and CEOs to pursue financial services over manufacturing, to favour white collar work over blue collar work, selling stocks over making things.

It started with the passage of North American Free Trade Agreement by the Clinton Administration with the help of Republicans in Congress. Before we get into the details, though, let’s be clear about what happened. The U.S. pursued a “strong dollar” policy when Robert Rubin was Treasury Secretary from 1995 to 1999 under Bill Clinton. The U.S. opened its consumer market to the world and began shipping manufacturing jobs overseas. In exchange, the U.S. got two things.

First, American consumers got cheaper goods via dollar pegs from exporters who kept their own currencies relatively cheaper than the dollar and sold into wide open U.S. markets. You saw a great disinflation in manufactured and retail goods and, not coincidentally, epic growth in China’s industrial production. Earnings for American firms who outsourced labour also increased, and were passed onto shareholders via rising stock prices (and more generous P/E multiples based on the rosy new scenario of lower costs, cheaper capital, and higher sales).

This led to a huge explosion in the current account deficit, most notably the trade deficit. America was buying a lot more than it was selling. But while the current account deficit climbed higher as a percentage of GDP under Rubin, America began to rack up a huge surplus in the capital account. And perhaps that was Rubin’s idea all along.

Foreign dollar holders recycled their trade (and later petrol) profits back into U.S. stocks and bonds. This drove share prices up and long-term interest rates (to which mortgage rates are linked) down. Consumers levered up based on rising asset prices (can you smell a housing boom?). And for awhile, everyone appeared to be getting richer, with more stuff available at lower prices, and ever more credit available to borrow against rising houses and shares.

Further, Rubin’s preference for running a surplus in the capital account favoured the boys on Wall Street. IPOs flourished. Investment bankers thrived. Financial product innovation exploded like a thousand brilliant suns.

And in another fortunate side affect, Federal tax coffers swelled as capital gains taxes poured in from Wall Street. Corporate tax revenues poured in as well. When you threw in booming social security payments from the workforce along with the swelling tax take, the Clinton Administration was even able to give the impression that the Federal budget was briefly in surplus in the late 1990s.

But Rubin’s gambit has not paid off so well for the bulk of the American workforce, has it? It sent jobs overseas and by pushing real interest rates down, disincentivized saving. Savings rates accordingly plummeted while consumers took on more debt to make up the difference between their falling real incomes and their expensive (self-chosen) standard of living.

What hath Rubin really wrought?

By preferring to run a capital account surplus, Rubin essentially conceded that the current account deficit-a function of Americans consuming more than producing and spending more than saving-was an a priori fact of global economic life. He assumed the current account deficit as a fact, and engineered a strong dollar to boost the capital account surplus, which also just happened to be a huge boon to the financial services industry from which Rubin came from. He figured we’d become a nation of spenders and consumers, not savers and makers.

By the time a weaker dollar rolled around in the last year of the first Bush term, there weren’t nearly as many American manufacturers left operating that could take advantage of it. They’d all left for a siesta in Mexico or the world’s new workshop in China. America could compete on price, but there was nobody around to do the competing.

And now today we have GM, a car company that exists to pay off its accumulated healthcare and pension liabilities. It cannot make enough money by loaning money to honour the promises it’s made to its unionised work force. What would Rubin do?

Well, we know that generally in the Western world, government policy makers (many of whom come from the financial services industry or benefit from the contributions that industry makes to their campaigns) have favoured a pattern of trade that generates capital account surpluses and current account deficits. This is good for you if you’re in the financial services industry. Not so good if you make cars.

There is not much at this point that Kevin Rudd and Barrack Obama can do about it, assuming they would want to. And the bigger problem, at least for the U.S., is that foreign trading partners and central banks are no longer recycling trade profits back into American financial markets. Perhaps it’s because they believe the risk free rate of return from sovereign U.S. debt is no longer risk free.

And perhaps they’re right. The U.S. bailout plans take on debt via government borrowing in order to shore up the badly damaged and over-leveraged balance sheets of Americas financial companies. No real value is created. And what kind of investment is that? Besides, so far, the bailout has been a continuation of Washington to favour the financial services industry over real manufacturing.

In the next few days, and with Democrats in Congress pushing hard for it, the balance sheet bailout of the real economy will begin. And when it does, we think it will accelerate the movement out of U.S. Treasuries and into cash or even resources. More on how this happens tomorrow.

Dan Denning
for The Daily Reckoning Australia

• The Challenge of a Balance Sheet Recession
• You Can Never Be Sure How Fabricated Income and Earnings Are These Days
• The Growing Pile of Cash On Corporate Balance Sheets
• Dow Jones Has Worst June Since Great Depression, American Model in Decline
• The Australian Resource Boom Isn’t Dead Yet

First, Ben Bernanke appeared in the U.S. Senate, with former Fed governor Paul Volcker by his side, and announced an incredible turnaround in Fed policy. Yes, he said, he and his fellow Fed governors were very concerned about weakness in the financial sector. And yes, they were very sympathetic to all those people who had high mortgage payments to make and all those people who had bought shares in Bear Stearns and other high-flying investment firms. But he went on to say that the Fed's primary mission was not to protect people from the consequences of their own mistakes; it was to protect the nation's money and its credit.

Bernanke went on to hint strongly that there would be no further rate cuts. Instead, Fed policy has turned back to its more traditional role of fighting inflation, he said. The Fed has become serious about stabilizing the value of the dollar.

"We can no longer ignore the economic consequences of price increases in fundamental resources, such as oil, wheat and iron ore," he said. "These price increases not only cause suffering on the part of average citizens who now pay an average of $3.23 for a gallon of gas. They also cause huge distortions and malinvestments in the whole world economy."

While he was still speaking, prices of stocks began to fall - in anticipation of higher interest rates - with the Dow closing down 535 points. The dollar rose against all foreign currencies; the euro dropped back to $1.30. A shop owner in Paris was heard to say that he actually liked Americans. Commodities fell, and the price of gold dropped to $750 an ounce.

That was just the beginning. At 11AM a group of corporate executives, present and former - including Stan O'Neal, Richard Fuld, Ray Irani, John Mack, Barry Diller and William Foley - appeared at a press conference in New York. The spokesman for the group startled reporters when he announced the group's intention to return a considerable part of its earnings to the shareholders for whom they worked.

"We've thought long and hard about this," said Mr. Fuld. "And we've come to realize that these salaries are just absurdly high. None of us can think of anything we've done anytime in the last ten years to warrant a salary of even half of what we get paid - much less the $38 million Stan got or the $322 million Ray got. Speaking for myself, I spent practically all of last year attending meetings, parties, and ceremonies - and frankly I can't recall what any of them was about. None of them needed me. And I'll tell you something else, when I attend those board meetings, half the time I don't even know what the accountants and lawyers are [there] talking about. We got together this morning and asked each other how those CDSs work, for example. None of us had any idea. And apparently, believe it or not, between us, we've got billions of them on our books."

As we've been saying here at The Daily Reckoning , executive salaries are preposterous. But we never thought we'd see the day when executives would admit it.

But the day wasn't over.

Hedge funds have had the worst quarter since they've been keeping records. Fifty of them went broke last year. About 8,000 more to go, by our estimate.

What is remarkable is the hedgies response. According to the American Hedge Fund Association, managers are reversing their typical "2 and 20" compensation package, to make up for their lost income. Instead of charging 2% of capital and 20% of performance (usually over a benchmark), they're charging 20% of capital and a 2% performance fee.

An article in the Financial Times demonstrated recently how the previous fee structure worked. Managers were encouraged to take risks, knowing that "heads I win, tails I lose someone else's money." Taking a big chunk of the gains, while not participating in the losses, gradually transfers ownership of the capital from the investor to the manager. This new system of fees merely speeds up the process.

Finally, Alan Greenspan himself stepped up to the microphones yesterday.

"I think it is time for me to apologize," said the former head man at the Fed. "This crisis in the financial markets; it's really my fault. It was on my watch that the bubble in residential real estate developed. It was while I was at the Fed, too, that the huge parallel banking system grew to its monstrous size - with trillions of dollars worth of CDSs, SIVs, MBSs, and all the other crazy alphabet derivatives, that are causing so much trouble.

"I knew all along that the only real money is money backed by gold. And I knew that there would be Hell to pay when people got carried away with the cheap paper-dollar credit that I was helping to make available. I remember that I said at the time that the growth in sophisticated investment vehicles helped spread out the risk. And I also told homebuyers that they should take advantage of those ARMS that they now regret.

"I am truly sorry for what I have done."

What a day!

Bill Bonner
The Daily Reckoning Australia

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