Of course it was misery for many of the test subjects. People were so eager to get out of the East German control group, they risked their lives jumping over the barbed wire. Then, when the wall was down, the population of East Germany collapsed...more than one out of every ten people moved to the West!

But it was a great experiment for economists. Too bad they didn't learn anything.

What they should have learned is that when it comes to making people materially better off, government spending is a poor way to do it. It's great for the few favored firms who help Washington raise and spend its trillions. It's great for Goldman, in other words.

But what if you don't have an inside track with the government? Well, you're out of luck. You get to stand in line to buy inferior goods and services - produced by government-owned industries and protected monopolies. That was what the East Germans did. And, of course, you get government bureaucrats telling you what to do...and preventing you from improving the quality of your life.

That's what they did in East Germany. And that's what they're doing, now, in the United States of America - in a less obvious, less heavy- handed fashion. Who owns the biggest auto company in the US? Who provides the finance for the finance industry? Who controls the health care and education industries? Who's the biggest employer? Who finances our houses? Who runs our banks?

Well...you know the answer.

But here's another question: who's headed for bankruptcy? Same answer.

What can you do about it? All you can do is to anticipate where this is heading...and position yourself to profit. Or, at least position yourself to protect your assets.

In that regard, you may want to replace the FED with the GLD, if you know what we mean. The Fed is derelict in its duty to protect your paper dollars. GLD - an ETF for gold - is a very simple way of doing your own central banking.

But should you buy GLD now? Ah...they don't make it easy, do they?

So, should you buy gold now?

A quick answer: it depends.

If you're buying gold for quick profits, you will probably be disappointed if you buy it now. The price has been going up for weeks. It's probably ready for a rest.

Also, gold moves up with stock prices - both anticipating an inflationary recovery. We think this will turn out to be a mistake. There is no real recovery underway. And no inflation either.

If and when stocks collapse, gold will go down too. At least for a while.

But if you are buying gold as the Chinese and the Indians are buying it - as a monetary reserve, not a speculation - there is no time like the present. Sometime in the future, we wish we could tell you when, gold at $1,100 will seem like a giveaway.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Gorbachev and the Most Complete Test in Economic History
• Gold is in a Bull Market
• The Codependent Relationship Between China and the United States
• U.S. Government Takes Over the Economy
• Housing and Unemployment Are Weaknesses in the U.S. Economy

The financial crisis of '08-'09 was not a head cold. It didn't go away.

It was more like diabetes, a stroke, or cancer. It was serious. Life threatening. We may not recover. Our only hope is to change our habits, undergo some nasty treatments...and endure a long convalescence.

But that's not what most people think. They are convinced that the feds gave the economy a miracle drug. It cleared up the trouble lickety split. Now, our troubles are behind us.

The Dow moved up 17 points on Friday, leaving it above the 10,000 mark. Gold rose too - it is at a new record high, only $5 below $1,100.

According to the news reports, the US economy is 'growing' again. Yes, that's the official storyline.

But wait, what kind of growth is this? David Rosenberg:

"All we can say is that if the overwhelming consensus is correct that the recession is behind us, then what we have on our hands is the mother of all jobless recoveries and whatever economic growth is being squeezed into the system comes courtesy of the most dramatic intervention by the government in recorded history, including the New Deal 1930s era. President Obama is now running fiscal deficits that would have made FDR blush."

The quacks at the Fed and the Treasury department have delivered the biggest jolt of adrenaline in history. People in the private sector won't spend? Heck, the feds will spend for them!

It took the Fed nearly one hundred years to grow its balance sheet - which is the foundation of the US money supply - to $800 billion. Then, after Lehman Bros. went broke, it doubled its balance sheet...to more than $1.8 trillion.

Early last week, the Fed announced that it would keep the firehose- sized IV in place. Then, by the end of the week, the G-20 meeting of finance ministers confirmed said they were all sticking with their stimulus programs.

You can't put that much cash into a financial system without getting some kind of reaction. Goldman is making record profits, for example. How does Goldman make money? It is finance business. It profits by offering credit. When credit expands, the moneylenders and speculators at Goldman make money.

The private sector isn't borrowing. Every day brings more proof.

Consumer credit contracted again in September - the 8th month this year.

Unemployment just passed the 10% mark, reports The New York Times.

"Small Businesses Hunker Down to Survive," says another headline story.

Another big bank went bust in California.

But while the private sector de-leverages, the public sector expands. Now, it's the feds who are doing the borrowing - about $1.7 trillion this year.

This is great for the people who help the feds finance their spending. But all it does is add more debt to the system. And debt is the real problem.

If former OMB director David Stockman is right, we'll see deficits over $2 trillion for a decade.

What people once took for absurd they now take for granted. Such as trillion-dollar deficits. For even with a hole in public finances equal to 13% of GDP the US House of Representatives passed a law overhauling the health care system, at a cost of more than $1 trillion.

What were they thinking?

Well, they were probably thinking that 'deficits don't matter.' And they were probably justifying the expense on the grounds that it was 'countercyclical spending' that would help pull the US out of its slump.

Whatever they were thinking, they weren't remembering what happened 20 years ago. It was 20 years ago today that the Berlin Wall fell, bringing to an end a 40-year demonstration project. The East Germans/Soviets wanted to show the world how well economists working for the government could run an economy.

And we found out!

Bill Bonner
for The Daily Reckoning Australia

• Government Debt
• Bankers Take Money From the Government and Use it to Speculate
• Feds Have Used the Correction to Increase Their Power and Add to Their Wealth
• Why Weren’t Economists On Top of This Thing?
• Where Do the Feds Get Any Money?

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

The Dow fell 67 points on Friday. Investors began to wonder if the news coming from the banks was as good as the first reports indicated.

For example, the Bank of America reported losing a billion dollars on its consumer accounts. It is all very well for JPMorgan and Goldman to make money. They're investment banks. And they're making money thanks to the US government's generous bailouts. They pay almost nothing for borrowed funds...in dollars, of course. And then they take the money and bet against the dollar. So far, those bets are doing pretty well.

Meanwhile, the Bank of America is a real bank. With real mom and pop customers. And the poor moms and the poor pops are going bust. They can't pay their bills. Or, at least so many of them can't pay their bills that it cost BoA $1 billion in loans write-offs.

The LA Times reports that "California job losses keep climbing." The unemployment in LA county has reached 12.7%.

Also, from LA comes news that millions of square feet of office space remain vacant. Between LA county, Orange county, and the Inland Empire, there are some 51 million square feet of empty offices.

We don't know who owns all this vacant space. But we can imagine who lent the money to build it - the big banks.

But lending money to customers is a tough way to earn a living. The more you lend, the more you make...until you lend too much. Then, you don't make anything.

Of course, speculating is a tough business too. But it's a lot easier when you can borrow from the feds at practically zero interest and the government also guarantees your debts. How can you lose?

Don't worry, dear reader. Bankers will find a way. They always do. Want an investment strategy that really works? Just figure out what the big banks are doing and do the opposite.

What are the big banks doing now? Mortgage lending? Nope. Credit cards? Nope. Business expansion? Are you kidding? How about mergers & acquisitions? Not really.

According to the news reports, the banks are making money by "trading." Trading what? Trading the dollar for things that are going up.

Look at the price of oil - over $79. And the price of gold - over $1050. Compared to each other - oil and gold - prices are stable. But against the dollar both are rising. In other words, people with dollars are trading them for oil and gold.

And not just oil and gold. While US stocks have gone up 50% or so in the last 7 months, emerging markets are up twice as much. Argentine stocks - who would have believed it? - have doubled. Indian stocks are up about 80%.

Well, let's see... If the big banks are getting rid of dollars... Hmmmm... Do we want to get rid of dollars, too? Maybe not quite yet. When speculators unwind all these short dollar/long oil, gold, stocks positions it will send the dollar flying.

Could the dollar surprise the speculators? Yes it could. This weekend Tim Geithner told the world that the "US must live within its means." There was no word on how his audience reacted. Surely some of his listeners must have giggled. Maybe at least one guffawed. A few must have rolled their eyes. Here was the man in charge of the Treasury of the world's biggest spendthrift. The papers announced this weekend that his deficit had reached a new record, over $1.4 trillion.

In other words, no nation ever lived as far beyond its means as the US.

In the 10 years, '97 to '07, consumers lived beyond their means. Then, suddenly, the shock of '07-'08 brought consumers to their senses. Now, they're saving...now it's the government that is living beyond its means.

The New York Times tells us that the turnaround in household accounts has been breathtaking. This year, the average household is expected to SAVE $4,643.

As usual, the NYT misses the point all together. It asks whether this is good for the economy and comes to the predictable conclusion that it is not. If consumers don't spend, the consumer economy won't grow.

At least you know, dear reader, what nonsense this is. An economy only appears to grow from consumer spending. When consumers spend money - especially when it's money they never earned - it triggers a phony boom. The economy gears up to produce more stuff. Then, when consumers have to repay their debts, the economy shrinks again. That is the story of the US economy 2001-2009.

A real boom, on the other hand, is one that results from increased earnings, not from debt. When people earn more they can spend more - without going further into debt and without having to stop in order to pay back the money they borrowed. But you don't get that kind of boom from consumer spending. You get it from saving money...which is then invested in new tools that increase output.

More output = more earnings = more spending power = real economic growth.

Simple enough, right?

But getting back to those savings...

If the average household saves $4,643 this year...that's about $500 billion savings for the entire nation. Yet, the US government is running a budget deficit of 3 times that amount.

Are we missing something or is that net dis-saving of about $1 trillion? In other words, the US is going deeper and deeper into debt. Whee!

Wait a minute. Didn't professors Reinhart and Rogoff just study nations that went too far into debt? And didn't it show that once you take on too much debt it is impossible to escape trouble? Don't governments always go broke when they borrow too much? And doesn't it always lead to crises - banking crises, credit crises, currency crises and political crises?

Yep.

Well, shouldn't we be running for shelter?

Yep.

Then, shouldn't we be dumping the dollar?

Yep.

But...it's not that simple. Markets always try to sucker in as much money as possible. Right now, people are afraid of the dollar. Just this weekend, the nations of Latin America began an initiative to create their own regional currency - the sucre - to compete with the dollar. And with gold and oil rising, many investors - especially the big banks - are betting heavily against the greenback.

Wouldn't it be just like Mr. Market to engineer a dollar rally...BEFORE we have a dollar collapse?

Yep.

Foreclosures are up 5% from the summer to the fall. Poor Donald Trump. Buyers of his condos in Miami are suing him. Prices have plummeted. Buyers think The Donald is at fault.

And poor Ted Turner is in the news too. He's down on his luck...and down to his last $2 billion. Jane is gone. So is CNN. He's struggling to "stay relevant," by working on women's rights issues and fighting global warming. And he's getting in tune with the times by downsizing:

"I've had the experience of being on top and riding the roller coaster down again, nearly to the bottom. You know, if you economize and don't buy new airplanes or long-range jets, or that sort of thing, you can get by on a billion or two."

And here's something interesting. Harrods is selling gold bars:

"From this morning, Harrods will start selling gold bullion and coins over the counter. In a sign that the credit crisis has left his gilded customer base largely untouched, Harrods owner Mohamed Fayed has teamed up with Produits Artistiques Métaux Précieux (PAMP), the Swiss refiner, to sell gold in the store. Aimed at private investors, the gold will be sold at the Harrods Bank branch on the lower ground floor of the West London store."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• In Europe, Banks Borrow Money and Lend it Back to the Government
• The Banks Should Hold More Capital
• Is the Real Economy Growing, Expanding, and Making Money?
• How to Buy Crude Oil for US$2 a Barrel
• The Scam of Ever-Rising House Prices

Today is a big day in China...it marks the 60th anniversary of the communist victory. "The Chinese people have stood up," said Mao, announcing the victory in 1949.

Then, over the next two decades, whenever the Chinese stood up...Mao shot them down himself. Mao's long march to power was a huge setback for human political progress - if there is any. The man was a thorough scoundrel and a complete incompetent at everything, except getting power and holding onto it. Every program was a disaster. When he set out to 'liberate' the masses, they ended up as slaves. When he set out to feed them, they starved. When he proposed to empower them with his "democratic dictatorship," they ended up with bullets in the back of the head.

But 60 years later, the commies are still in power. China is still red.

And yet, thanks to the curious way the world turns, China's economy is now freer and more competitive in many ways than the United States. Go figure.

As economies age, more and more people become 'rentiers.' That is, they get some special privilege...some inside angle...some conniving advantage. The latest numbers, for example, tell us that almost half of all households pay no federal taxes. They collect benefits - jobless benefits, food stamps, education, day care, Medicare, Social Security - without contributing to the system that provides them. Add to this number the millions of households that pay taxes but receive a large part of their money from the government itself - employees, contractors, lobbyists, etc. - and you have enough to win any election in the country.

But the welfare chiselers and food stamp cheats are small time crooks. The big crooks go for billions. John Crudele in The New York Post:

"...Sept. 18, 2008 [US Secretary of the Treasury...Henry] Paulson placed his first call of the day at 6:55 a.m., to Lloyd Blankfein, who succeeded Paulson as CEO of Goldman. It's unclear whether the two connected because Blankfein called Paulson minutes later.

"And then Blankfein placed another call to Paulson at 7:05 a.m. for what looks like a 10-minute conversation.

"After that Paulson called Christopher Cox, Securities & Exchange Commission Chairman twice; British Chancellor Alistair Darling and New York Federal Reserve head (and now Treasury Secretary) Tim Geithner two times.

"Then Paulson took another call from Goldman's Blankfein.

"It wasn't even 9 a.m. yet - 30 minutes before the stock market was to open - and Paulson and Blankfein had already exchanged three phone calls."

It pays to have friends in high places. That was the day the market learned of Paulson's bailout proposals. Could Goldman have gotten word before others? Hey, we're not accusing anyone...

Bill Bonner
for The Daily Reckoning Australia

• Rising in Defense of Goldman Sachs
• Pension System: A Conversation With Chile’s Former Labor Minister
• Only Hope for Obama is that the Economy Revives
• No Evidence of Recovery as Unemployment Getting Worse
• U.S. Government Doing So Many Stupid Things All At Once

Well just a day after highlighting the size and scope of the Gorgon LNG project in Western Australia, we have news that it really is a big deal. It is so big, in fact, that Martin Ferguson, the Federal Minister for Energy and Resources, said Australia is emerging as an "energy superpower."

Shazzam!

Ferguson was in Beijing last night to sign a deal sending $50 billion worth of Gorgon gas to China over the next twenty years. Exxon Mobil will sell the gas to PetroChina and the Australian government will siphon off as much as $40 billion in tax and royalty revenues over the life of the project.

China gets energy. Exxon gets profit. Australia gets jobs and revenue. Investors get a whole new industry to play with.

Mind you, this comes after the Gorgon consortium agreed to sell $25 billion worth of gas to India over the next 20 years as well. The deals are truly flowing. And there could be more. "As well as Gorgon and Woodside, there is the Sunrise project in the Timor Sea," Ferguson says. He's right. In fact, there are four major LNG zones in Australia.

Back in April we wrote this in a weekly update to Diggers and Drillers subscribers, "The other three major areas of LNG development are the Browse Basin (off the Kimberley Coast), Darwin (for LNG from the Timor Sea), and Gladstone in Queensland (the proposed terminal for export of coal-seam-methane projects in the Bowen and Surat basins). Under the Howard Government, Australia had as ambition the production of 60 million tonnes of LNG per year for export (mtpa). The current capacity of the four regions, according to industry analyst David Wood is more like 90mtpa. That would be more than half of current global production of 175mtpa."

Some of those regions are considered "conventional" LNG zones. Others, like the coal-seam-methane district in Queensland, are "unconventional." There are a few small firms operating there that Kris Sayce has been all over at the Australian Small Cap Investigator. Ferguson is excited about these too. "We also have an emerging industry on the east coast -- coal-seam methane. So we now have the opportunity, in my opinion, over the next 12 to 18 months, of getting investments of up to $100bn in the LNG sector."

With all that investment pouring into LNG production, and all those contracts pouring money into corporate and government coffers, you have to wonder what all the fuss about iron ore is over. In dollar terms anyway, it seems like less of a big deal. Aren't Australia and China getting along swimmingly?

For example, yesterday we learned that Andrew Forrest's Fortescue Metals Group will cut iron ore prices by 35% from last year's price in exchange for $7.2 billion in loans to fund expansion of its operations in the Pilbara. We should note that the price cut was negotiated with the China Iron and Steel Association (CISA) and that the loans will come from Chinese banks.

What gives? It's not likely that Fortescue's agreed price cut of 35% from last year's benchmark price (which is just two percent larger than what BHP and Rio have already agreed to with Japanese and Korean customers) is going to influence the negotiations between Rio Tinto and the CISA. But that seems to be the message behind the deal: you play nice with us and we'll loan money to you.

Fortescue has agreed to sell 20 million tonnes of ore over the next six months at the discounted price. Keep in mind that annual seaborne iron ore trade is closer to 400 million tonnes a year. It is a big deal. But not a huge deal, certainly not the sort of deal that would bring down the spot price of iron ore, which at over $110/tonne, is higher than the target benchmark price being sought by Chinese firms.

In any event, it looks to us like pricing power in the iron ore business is moving toward a new equilibrium. The annual price negotiations in which the ore producers are represented by one party (that can be squeezed by Chinese political machinations) and the steel makers are represented by another party (in this case, the CSIA, which seems to have made a meal of it) will be replaced.

But with what? BHP wants a benchmark index. China, seeking price certainty and the control a large customer expects to have, resists.

Whatever happens, we're beginning to think that energy exports will matter a lot more to Australian bottom lines than iron ore exports. Of course BHP and Rio are large diversified miners and employers. Troubled relations with China for to the two largest miners by market cap on the ASX are not good for investors.

But what is good for investors is the LNG boom. The big risk, as with any commodity, is that increased demand leads to over-supply. But that is not something we're worried about just yet. These projects take years to develop and secure permitting. Just in time LNG doesn't exist.

That means the firms with the biggest head start and the best prospective areas are going to be worth punting on. At least that's the idea anyway.

But while we're at it, let's report that at least one major investment bank is predicting a second commodity boom driven by a shortage of capital spending and resurgent demand. You always wonder if Goldman Sachs is just talking its own book because it's already made its bets in the sector. But for what it's worth, Goldman is predicting another commodity boom.

"We expect a commodity supply shortage in 2010," a company report proclaimed recently. "We have long emphasized that the commodity problem is, at heart, a supply shortage due to decades of suboptimal investment, which has been exacerbated over the past year by the sharp drop in prices and tight credit conditions. As the commodity markets rebound with the broader global economy we expect a redux of 2008 when severe supply constraints forced the rationing of demand through sharply higher prices to keep the markets balanced."

Goldman argues that the, " imbalances have actually worsened owing to the sharp drops in prices and tight credit conditions that have further impeded investment. In this context, it is important to emphasize that the commodity crisis is, at heart, a supply shortage. Although emerging market demand growth has been strong, the structural rise in prices that has been a key feature of commodity markets for the past several years would not have occurred if supply were sufficient. In reality, trend demand growth for many commodities has been slowing due to supply constraints that are restricting overall demand growth despite robust emerging market demand growth."

Goldman's note goes on to recommend a handful of blue-chip firms that will benefit from higher demand growth. Firms like Cairn India, Cameron (US), CNOOC (China), Hess (USA), Peterobras (Brazil), Suncor Energy (Candada), and more. For Aussie investors, there are a smaller number of energy blue chips and a larger number of excellent speculations.

Dan Denning
for The Daily Reckoning Australia

• The Iron Ore Pricing War Between China & Australia
• Buying Oil on Sale as U.S. Dollar Gets Weaker
• Rio Scraps Deal to Sell to Aluminium Corporation of China
• Giant Costco Opens in Melbourne!
• Bailout Deal Will Expand China’s Influence in U.S. Economy

Crackpot ideas! Corruption! What next?

But the most breathtaking scene is the one no one seems to notice...

Perhaps it is because we have our head in the clouds...so far above the surface of everyday life that we can look down and see what is happening...

..or perhaps because you have to be a connoisseur of absurdity to appreciate it...

..strange...bizarre...almost surreal...even when you see it, you don't quite believe it...

First, the voters ruined themselves...now it's the government's turn!

The US federal government is digging its own grave...bankrupting itself with its eyes wide shut. And it's not alone...

Look back a little more than 100 years ago, and you'll see that something similar happened. Europe went to war. No one knew why. No one knew what he stood to gain. But whether he was a kraut, a frog or a Tommy...he kept at it for four years - until every major government of Europe was broke. Most of them collapsed completely. All of them were broke. Germany and Russia, with the added burdens of war reparations on the one hand, and Bolshevism and civil war on the other, forgot their manners. Both were soon butchering their own people.

In the Great War the generals led the way to calamity. Now it is economists...

Some observers think the economy is recovering already. Others think it is not. If it is not recovering, it is because it didn't get enough stimulus, they say. If it is recovering, it's because the stimulus has worked.

"Fewer layoffs expected as recession winds down," says a headline this morning from one of the wire services.

The Dow fell 25 points yesterday...but it's still in bear market rally mode. With a little luck, it could go to 10,500.

(Of course, it can do whatever it wants...we're just guessing, based on the experience of other major crash/depression episodes in history.)

Oil trades at just under $72 this morning. Gold is at $960.

It is "business as usual at Goldman," says a news report. Which is to say, big bonuses for the bankers. The top eight US banks got more than $170 in bailout money last year. They paid about 20% out in bonuses.

But now the press and the politicians are on their case. It looks like they might have to ease up on the bonuses...at least until the heat is off.

The news is mixed. German factory orders are up...but the Bank of England says the recession is worse than expected; it says it will continue buying bonds.

Americans are raising chickens in their backyards again...even in places like Brooklyn. But the latest headlines tell us that requests for unemployment benefits are running below expectations.

The housing market is supposed to be stabilizing...but new waves of defaults, resets and foreclosures are coming. Half America's mortgages will be underwater by 2011, says a Reuters report. And Deutschebank warned that construction loans were starting to go bad too.

But the big story? Stimulus!

Here is the International Herald Tribune on Monday:

"More Stimulus is Needed to Spark a Strong Recovery," is the headline. According to the IHT, stimulus is working. And it will work even better if there were more of it.

Once underway, the WWI generals used the same sort of logic. If they were winning, it was because they put so many resources into the campaign. If things were going against them, they called for more men...more guns...more ammunition.

Of course, once a war has begun, it is hard not to want to win it. One hundred years later, it seems obvious the combatants should have called the whole thing off. They could have spared themselves a lot of misery.

But that's not the way history works. She may be absurd, but she rarely does things by half measures. Once called to action, soldiers fought to win...even at the cost of their own lives.

And now the world's central banks, Treasuries, and legislatures are at war. With economic strategists egging them on, they have declared war on all that they find unholy about capitalism - deflation, bear markets, and the down swing of the business cycle. John Maynard Keynes, that much-revered strategist from the Depression Era, tells them this is a fight they can win. And they believe it!

Of course, these are the same people who saw nothing to worry about in 2006...the same people who have no idea what is going on - and have the track record to prove it!

Can you really fix a debt-saturated economy by pouring on more debt? We know the answer, don't we? When you borrow money you take something away from the future and bring it into the present. That is not a bad thing...if you are doing it to increase your future output. In that case, you'll be able to pay back the loan with your extra earnings. But if you borrow from the future only to consume, the future waits for you...like Shylock waiting for his pound of flesh...

The future caught up with American consumers in 2007. But the feds learned nothing...and soon it will be a ton of flesh the future will want.

Bill Bonner
for The Daily Reckoning Australia

• Obama’s New Stimulus Program
• If the US Economy is Really Following Japan Things Will Get a Lot Worse
• Where, Exactly, is this Economy Headed?
• AIG to Receive $85 Billion Loan from Fed
• Normally Small Businesses Lead the Economy Out of Recession

The depression darkens because people are not just being laid off - their jobs are disappearing. They do not get called back to work. Instead, they stay unemployed until they run out of unemployment benefits...and then the statisticians in Washington drop them off the unemployment rolls. Currently, the first batch of those people to reach the end of their benefits came this week. Last we looked, the Pennsylvania legislature was passing a law so they could continue drawing benefits for a few weeks more.

We've mentioned John Williams and his excellent service called Shadow Government Statistics. He looks at the numbers and figures out how they are twisted and tortured...and then figures out what they would be if they were treated properly. Currently, the unemployment rate nationwide officially is almost 10%. But if you computed the unemployment numbers the way they did back in the Great Depression, Williams says one in five people are out of work. In some places the figure is as high as one in four.

In other words, the unemployment numbers are already beginning to look like those of the Great Depression. But that's true of almost all the numbers. They've all got a '30s era look to them. And if you stopped water boarding them, they'd tell a similar story. Almost all the indicators are worse than any we've seen since WWII.

Unemployment, trade, defaults, foreclosures, bankruptcies, prices, manufacturing...you name it and you have to go back to the end of WWII to find similar numbers. Of course, at the end of the war, the wartime economy shut down. Millions of people who have been in uniform...or making tanks and airplanes...were suddenly out of work. Economists thought the economy would go right back into the Great Depression. Instead, it boomed.

Those soldiers and their families had savings. They had pent up demand - they hadn't bought a new car in 10 years...they were young...they got married...they had children...they needed baby cribs and houses. We remember going to look at one of the first major suburban developments as a child - Harundale - in Maryland, built by the Levitt Company.

It was a horrible place, but you could buy a house for peanuts...on credit. And it set the pace for the suburban consumer credit expansion of the next half a century.

But what was normal for so many years is not normal any more. Now, consumers are paying off debt faster than any time since 1952. The government, however, is making up for them. Goldman may no longer be able to push more credit onto the public; but it can push one heckuva lot of debt onto the public sector. Wall Street firms helped households ruin themselves in the Bubble of 2003-2007. Now they're doing the same for the government, helping the feds raise money on a scale never seen before in human history.

As we said...no wonder they're making money. Too bad.

Bill Bonner
for The Daily Reckoning Australia

• If Americans Do Not Return to Work, There Is No Recovery
• Bad News if You Are Afraid of Inflation in Consumer Prices
• We Expect No Recovery from the Economy
• Housing and Unemployment Are Weaknesses in the U.S. Economy
• Consumer Prices are Rising at About 10% Per Year

He was flattered...and grateful for the attention.

But we're not kidding ourselves. Readers come up to us at conferences and tell how much they enjoy reading the DR. We wait for questions about Quantitative Easing, the Trade of the Decade, Empire of Debt or any of our other important themes. Instead, what they want to know about is:

"How's your gardener doing? What's Maria doing in Los Angeles? Did you ever figure out what happened to your missing cows...?"

Readers know what's important. They want to know more about what really matters.

Still, we are foot soldiers in the lonely battle against economic claptrap; we must march on!

Yesterday, came more evidence that the depression is over. The Dow shot up 188 points. From a technical point of view, if you believe that kind of thing, it looks as though the rally has farther to go. We recall setting a target of Dow 10,000. Perhaps we will get there.

Oil traded at $67 yesterday. Gold rose to $954 and bond yields on the 10-year T-note rose to 3.7%.

All of this sounds vaguely inflationary...and vaguely bullish. Besides, Goldman stock is rising. And as we all know, what's good for Goldman is good for the country.

Wait...we're kidding...right?

Yes, we are kidding. What's good for Goldman is generally bad for the country. Goldman makes money by separating investors from their money. Nothing wrong with that; someone has to do it. But the big banks are most profitable when speculation is rampant and debt is growing. That is, when people are going further and further into debt...and speculating on rising asset prices. We know you don't really prosper by borrowing and gambling. But that doesn't make casinos unpopular, or lenders unlawful. Bankers, like undertakers, benefit from human frailty. At least, they benefit as long as the government bails them out. Otherwise, they fall victim to their own human frailty.

But this is a minority opinion. Most economists disagree with us. And there are so many of them...if all the economists who disagreed with us were laid end-to-end...it would be a good thing. They believe that the economy is stabilizing...and on its way back to normal. Trouble is, 'normal' ain't what it used to be.

Wall Street banks are making money, 'tis true. But they're not financing new businesses...or factories. They're not aiding the process of capital formation nor allocating capital in ways that will result in new jobs and new industries. Instead, they are refinancing old debts...and speculating on zombie assets. This will not increase the real wealth of the planet. Instead, money just changes pockets. Which, of course, raises an interesting question; where did all this money come from?

If Goldman's pockets are fatter, whose are thinner? If the four biggest banks earned a combined $11 billion in the last quarter...who did they take the money from? Who's got that kind of money?

Meanwhile, we found out this week that the feds have wagered an amount equal to 170% of GDP in their attempt to bailout the world (more below). Part of that money was used to buy Wall Street out of the investments that they didn't want. Which ones were those?

Well, the ones that didn't work out.

No wonder the banks are making money.

But while the banks are making billions, cometh another report from another sector - manufacturing. Caterpillar announced its results for the second quarter too. Profits were down 66%. In other words, while the banks were making money speculating with taxpayer's money, Caterpillar was trying to make things and selling them to customers. Caterpillar not only makes things; it makes things that help other companies make things. Things with motors...big things...things that make noise and give off exhaust...things you use to dig holes and move dirt...things you need if you're going to have a real economic recovery. Unfortunately for CAT, these things aren't selling.

So what does this tell us? Well...it suggests that there is no real economic recovery at all. The real economy is suffering...sinking...and shutting down.

The banks are not earning their money helping Caterpillar expand. They're making their money not because of a recovery, but because there isn't one. In other words, they're profiting from the financial stress of the early stages of a depression. There's a post-crash bounce...and the government is sending a lot of money their way.

Bill Bonner
for The Daily Reckoning Australia

• JPMorgan and Goldman Sachs Making Billions in Profits
• Rising in Defense of Goldman Sachs
• Warren Buffett is Buying Four Percent of Goldman Sachs
• Aren’t You the Least Bit Suspicious that Goldman is Talking Up the Banks?
• Meredith Whitney and the Buy Recommendation on Goldman Sachs

Let's review our own narrative: deflation now, inflation later.

It's very simple. Maybe too simple. After a half a century of credit expansion, we now have a credit contraction. In this sense, everything is happening as it should.

There was a crash and credit crunch at the end of last year. Then, the feds panicked. They fought back with monetary and fiscal stimulus. Rates were cut to nearly zero. The Fed flooded the system with cash and easy credit - buying up Wall Street's bad investments...propping up bad banks...and guaranteeing trillions worth of bad debt. And the federal government passed a stimulus program that authorized more than $700 billion in spending.

Beginning on March 9th, we also got a big bounce in the world's stock markets - just as we should. US stocks are up about 40% since then. Some foreign markets are up even more. Russian stocks, for example, have more than doubled. Chinese stocks are up more than 60%.

As the bounce continued, people began to get the wrong idea. They thought they saw 'green shoots' and the 'light at the end of the tunnel.' But if the economy is really improving, we haven't seen much evidence of it here at The Daily Reckoning headquarters. As near as we can tell, housing prices are still going down and unemployment is still going up...and most important...people are still acting as though we were on the downward slope of the credit cycle. The latest numbers we've seen show that they saved more money in the first half of the year than the total in extra 'stimulus' that they received. Savings - last reported at 5% in this space - are now close to 7%. This is a just what you'd expect. But it is a huge turnaround, too.

As to housing prices, there are a million option ARMs still to be reset over the next four years. They won't peak out until 2011...with average increases of about 80%. That will cause hundreds of thousands more houses to be dumped onto the market...and probably push the bottom of the housing decline to 2012.

As long as housing prices are falling, jobs are declining, and consumers are inclined to save rather than spend, there will be no real recovery.

In our book, recovery is impossible anyway. Because the pre-crisis economy had reached the terminal stages of the credit cycle. It was like someone in the terminal stages of a fatal illness. After they have died, you don't wish that they could recover...and be just like they were before they died. They were sick and dying then! No, you sign the book of memories and condolences and turn the page. You let new life take the place of the dead. You move on.

But the feds have their ghoulish agenda. They have the poor thing on life-support. One tube feeds the oxygen of easy credit. Another drips in more 'stimulus.' The economy rattles every time it breathes. Dead companies, such as GM, say they are reborn. But take away the tubes...and they collapse. Dead-in-the-water households learn to live submerged in debt ...with special tubes provided by the feds - such as the underwater mortgage refinancing offered by Fannie and Freddie, where homeowners can get up to 125% of the value of their houses. And the brain dead economists at the Fed and the Treasury department continue to offer their elixirs and panaceas - even though they have never worked.

Everything is happening as it should, in other words. But what happens next?

Ah...this is where it gets tough. Because we're losing our faith. We figured the economy would continue to worsen (after all, you can't correct a half-century credit expansion in a few months)...and that the feds would continue to fight it. As more and more people lose their jobs, the feds would become more and more desperate. Gradually, they'd come to see that they needed to use stronger, more experimental techniques. This would lead them to be a bit bolder with their 'quantitative easing,' otherwise known as "a little technology called the printing press," to quote Ben Bernanke.

We figured that sooner or later, the feds would get the hang of causing inflation. So, we could just buy gold and wait.

But now we see; we are trapped...just like the feds themselves. Do we hedge against further economic deterioration... deflation... and falling asset prices? Or do we hedge against inflation...a falling dollar...and a collapsing bond market? What if we hold our big position in gold...and feds NEVER are able to cause inflation? What if the pain of the depression is never severe enough to make them go whole hog on quantitative easing? What if the Chinese put it to them straight: if M2 goes up more than 10% a year...we stop financing your deficits? Gold could sink...or go nowhere...for the next 10 years.

Are we prepared to sit it out...? It's time to go back to the pub...

This morning our thoughts turn to Goldman.

The news yesterday told us that Goldman execs paid themselves $700 million in bonuses - while receiving bailout money. This morning, stocks in Asia are rising; they say it's because Goldman had a good quarter - wiping out its loss from the last quarter of last year...

The news:

"Goldman Sachs reported second quarter earnings of $2.72 billion, up on last year's $2.05 billion, and easily surpassing forecasts thanks to big gains in trading and underwriting."

The New York Times offers more details:

"Analysts estimate that the bank will set aside enough money to pay a total of $18 billion in compensation and benefits this year to its 28,000 employees, or more than $600,000 an employee. Top producers stand to earn millions.

"Goldman Sachs is betting on the markets, but the markets are also betting on Goldman: Its share price has soared 68 percent this year, closing at $141.87 on Friday. The stock is still well off its record high of $250.70, reached in 2007.

"In essence, Goldman has managed to do again what it has always done so well: embrace risks that its rivals feared to take and, for the most part, manage those risks better than its rivals dreamed possible.

"For all its success, Goldman is not impregnable. In addition to the federal money it took last fall, it benefited from the government's bailout of the American International Group, being paid 100 cents on the dollar for its $13 billion counterparty exposure to the insurer, and it has $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corporation."

Not everybody likes a winner. There are some who think there is something underhanded and un-American about how Goldman does business. Making billions trading bonds? It is almost as if they knew better than anyone else what the feds would do next. Maybe they do.

The DR Australia's Dan Denning offers his two cents on the subject:

"We'd suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America." Furthermore, Denning points out, most other American financial institutions are continuing to play "hide the bad asset."

"A New York Times story suggests 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.

"'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," Denning continues. "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 get a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent)...

"The default and foreclosure data coming out of the US housing market suggest the banks are kidding themselves, or misleading shareholders, or both!" says Denning. "It's the sort of calculated mistruth that can cause a short-term crisis to last years and years. The correction is postponed through phony accounting. It leads to an 'Ushinawareta Junene,' or 'lost decade,' as the Japanese say."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Have the Feds Given the Economy a Miracle Drug?
• Hiding Level Three Assets Won’t Solve the Problem
• Feds’ Plan is to Reflate the Economy
• Economy Free to Recover?
• Level 3 Assets Growing in All Five U.S. Investment Banks