For the past 60 years, corporate debt has grown faster than the economy - 4.1% annually for debt, compared with only 2.7% for the economy as a whole. In short, more and more debt went toward producing each dollar of GDP growth.

What if this 60-year trend reverses?

In fact, I think that is the likely scenario. The deleveraging will take some time...and it won't be fun.

"Today's overleveraged assets will become tomorrow's underleveraged assets, and vice versa," QB Partners, a hedge fund, explained in a recent letter to shareholders.

What will this new world look like? More people will save more money. And they will focus more on preserving that wealth than on making a big score. We've been here before. Michael Farrell, the chairman of Annaly, says the psychology of people will change as it did for those of 1930s, as he discussed on his company's first-quarter conference call:

Exhausted by the uncertainties of the 1930s and 1940s, the older generation just felt lucky to be alive and they settled into a time of saving, preservation of capital and lowered expectations as consumers.

If that kind of financial orthodoxy takes root, then leveraged assets like real estate and bank balance sheets face a long period of stagnant returns as they continue to deliver - that is, as borrowers and lenders ratchet down the debt on these things. (I find it ridiculous that government officials want us to believe that the US banking system is OK at 25-to-1 leverage. The banking system's insolvency will become more apparent as it continues to take losses from bad debts made during the bubble.)

Deleveraging puts pricing pressure on leveraged assets. Banks must raise capital, diluting their shareholders and hurting their stock prices. Real estate owners must sell property to raise capital to defend other properties, thus putting pricing pressures on real estate assets. And so on...

So as an investor, it will pay better to stick with the unlevered assets, which face no such head winds. After all, there is no pressure to sell an asset with no debt, no ticking clock. "What are the most underleveraged assets?" you ask. QB Partners gives the answer: hard assets and natural resources.

The ultimate unlevered hard asset may be humble old gold.

In fact, something important is happening in the gold markets right now. All through the 1990s to the present day, the world's central banks were net sellers of gold. Europe's central banks, for instance, have sold 3,800 tonnes of gold in the last 10 years. According to The Financial Times, this move has cost them $40 billion, and that's with gold at $900 an ounce.

Well, too bad for them. But suddenly, that recent habit of selling gold is changing. Last year, central banks sold only 46 tonnes, which was the lowest amount in 10 years.

As the FT reports: "Sales in Europe have slowed to a crawl and fresh demand is emerging elsewhere and the financial crisis has helped to highlight gold's value in turbulent times." In fact, we may soon see central banks flip to net buyers of gold.

China has doubled its holdings of gold this year and is now the world's fifth largest holder of the metal. China is likely to be a buyer of gold for years because its gold holdings are still very small relative to the size of its total reserves. Gold represents only 1.6% of China's reserves, versus a global average of nearly 11%. To further diversify its reserves - just to get to average - would require significant amounts of gold.

In a post-2008, deleveraging world, it is the unleveraged assets that will outperform against those saddled with debt. It's another plank in the case for gold, which just seems to get stronger with each passing month. "A new chapter has begun in the gold market," the FT opines. Indeed, it has.

The International Monetary Fund, never known as a wise handler of money, is selling a bunch of gold. India bought half of it. A number of emerging market central banks are also upping their gold exposure. Maybe these CBs are onto something.

Russia's gold holdings now make up 4% of its foreign reserves, compared with only 2.2% at the beginning of the year. Smaller central banks are also being crafty. Ecuador's gold holdings have more than doubled since the start of the year - to 54.7 tons, from only 26.3 tons. Gold now represents 32% of that country's reserves. Even Venezuela is buying gold. Gold now makes up 36% of its reserves, compared with only 23% in 2009.

So who is the sucker here?

Perhaps central bankers see more clearly than most what the effect of all their money creation will be. In recent months, we've seen a truly unprecedented boom in bank reserves. Bank reserves drive money creation. More money means money buys less - and the gold price should rise.

Then there is this chart of the Shadow Gold Price. In the old days of the Bretton Woods Agreement, countries had to maintain certain ratios of gold against their currencies. The Shadow Gold Price aims to replicate this discipline. So for the US, the Shadow Gold Price is Federal Reserve Bank liabilities (bank reserves) plus money in circulation divided by US gold holdings. Also on the chart, you can see the spot price of gold.

The important thing here is that you see how massive amounts of money creation have barely made an impact at all in the gold price - so far. Gold is fundamentally cheap compared with all the money added to the system in recent months.

As Paul Brodsky and Lee Quaintance of the hedge fund QB Partners write:

"If one allows for even a small probability of a future monetary system that reflects more honest/tangible money, then a quick glance at the graph above makes it easy to conclude that spot gold is fundamentally cheap. Even if this is too far a stretch for market participants skeptical of such a radical change in monetary policy, it is reasonable to conclude that the prices of spot gold and the Shadow Gold Price should converge somewhat over time."

They note that the spot gold price has never been so cheap compared with the Shadow Gold Price. For parity to set in, gold would have to trade for $16,000 per ounce! No one is predicting $16,000 per ounce gold. In any case, it shows you the risk of holding paper - and bonds - on the eve of a massive devaluation of the dollar. Maybe the central bankers of Russia, Venezuela and Ecuador understand all of this better than they let on and that's why they are buyers of gold.

It seems pretty obvious to me that if you create a lot of money, you are going to destroy the value of that money. And in that case, you want to own something other than that money.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• India Beats China to Walk Away With 200 Tonnes of IMF Gold
• IMF Deems Gold An Idle Asset
• Stock Prices Down Signals Bears to Hold onto Cash, Treasuries and Gold
• Gold Bought by Some of America’s Most Successful Investors
• Fed Trying to Push Private Investors into Riskier Asset Classes

There are certainly steps that can and should be taken to strengthen the private sector when the economy turns down, but so far as public spending is concerned, it will almost invariably have a corrosive effect on the economy's strength and resilience. Yet this is not meant as a counsel of despair. The business cycle is a cycle, and will end rather sooner than most people expect, unless the steps taken to fix the problem overwhelm the natural processes of an economy to fix itself.

Free enterprise economies have amazing recuperative powers if the market is given its chance to right itself from the imbalances that had caused the recession in the first place. Nevertheless, almost every government across the world has not seen it that way and has attempted to fix things with a spending program of their own. Such expenditures can in my view do nothing but harm.

Following the first week on testimony to the Senate, there was an editorial page article in the Weekend edition of the Australian Financial Review (October 10-11) which contained the following:

"At a recent Senate inquiry into the merits of the Rudd government's fiscal stimulus, some academic economists questioned the efficacy of it all. After hearing one university economist critique the big-spend strategy, senator Doug Cameron declared that the witness's comments merely confirmed in his head that one should never let an 'academic economist run the economy'.

"Cameron thundered at the witness: 'Why have the International Monetary Fund, the Organisation for Economic Cooperation and Development, the International Labour Organisation, the treasury of every advanced economy, the Treasury in Australia, the business economists around the world got it so wrong and yet you in your ivory tower have got it so right?' The witness replied that Keynesian economics 'had been one of the greatest catastrophes for economic theory in the West'."

The university economist in question is none other than myself and the question from Senator Cameron is indeed a good one. And when it is put in quite that way, it is even perplexing to myself. How have they all got it so wrong?

And the thing that is most bewildering for others is that my critique of these Keynesian policies has a definite plausibility about it while the approach taken by the IMF, the OECD, the ILO, the treasuries of every advanced economy around the world including our own, and all of those business economists from everywhere, look out of touch.

Senator Cameron raised the same issue with the Secretary of the Treasury, Ken Henry, when he provided his own testimony to the Senate. This was the relevant exchange:

Senator CAMERON - We have had lots of academic economists come before us and argue, I suppose, their academic bias in terms of some of these issues. We have had lectures on Say's Law, we have had lectures on the evils of Keynesianism and why we should be looking at Hayekian economic approaches. I am just wondering if all that lecture we got was really relevant in terms of the practical circumstances that governments and treasuries around the world face. Have you got any view on that? I am sure you have looked at some of the commentary and analysis that has been put to the committee. We have got to weigh all of this up, I suppose.

Dr Henry - I used to be an academic economist myself. It is easier to be an academic economist.

Senator CAMERON - Are you going to leave it there?

Dr Henry - No, look, the issues that have been raised in testimony before the committee, on my brief reading of them - and I have not read them perhaps as closely as I might have in answering this question - it is not that the issues that have been raised should be entirely discounted in all circumstances; certainly not. But, whilst being very aware of those issues for many years, I can tell you that, confronted with the crisis that the world has been dealing with these past 12 months or so, those few quibbles with the use of expansionary fiscal policy - or expansionary monetary policy for that matter - or other actions of government to prop up credit markets are not ones that I considered should detail us for too long. They were rather quickly put aside.

Now here, too, it is myself that has been obliquely referred to. I am the academic economist who provided the "lectures on Say's Law". And let me also just accept here in passing that it is easier to be an academic economist than the Secretary of Treasury. The responsibility must be unbearable for anyone of conscience, as Ken Henry most assuredly is. He possibly more than anyone else in Australia wants to get this right.

My worry is that he along with the IMF, the OECD, the ILO, the treasuries of every advanced economy around the world, and all of those business economists do have it wrong. That we will find ourselves in a year or two wondering how we ever got into the mess we will then be in, and worrying for quite a number of years after that about how we are going to get ourselves out, is exactly what I think.

Say's Law sounds like an archaic principle since it is named after J.-B. Say who wrote the first edition of his treatise on economics in 1803. He did not, in fact, invent this theory but what is most important in dealing with Say's Law is that it is this principle that Keynes made it his purpose to see removed from economic discourse. It had been the basis for the theory of the cycle right up until 1936, accepted till then by every economist across the world.

By invoking Say's Law, I have some of the greatest economists who have ever lived most decidedly in my corner. But from virtually the day that Keynes's General Theory was published in February of that fateful year 1936, Say's Law has completely vanished from economic discourse. No one teaches it, no one studies it. Yet if one understands this principle, it would be impossible to see anything other than folly in the economic policies that have now been put together everywhere to deal with the present downturn.

Let me therefore give you an analogy that might make clear what I see wrong with the stimulus packages we find supported by this vast array of economic judgement.

Suppose there were a mining town in some remote region of Australia that had been mining some particular mineral for a hundred years but for some reason the demand for this particular mineral had completely fallen away. Here in this mining town are thousands of people, most of them going about their lives doing nothing related to the mining industry itself. There are shops and transport, schools and banks. If it were then decided that what needed to be done was to maintain town life through a stimulus spending program through outlays on a series of government-chosen projects - school assembly halls, say, or insulating people's homes - most of us, I think, would see that as a phenomenal waste of public funds. Worse would be if that expenditure was concentrated on a series of outlays not one of which would themselves generate a positive economic return but were chosen as just an expedient to pump money into the town. We would find anything like that bizarrely unacceptable.

And the reason we would reject such expenditure would in part be because it would delay the necessary adjustment process as the townspeople come to recognise that their futures lie elsewhere in undertaking different kinds of work, and in part because we would recognise that the debts accumulated in paying for the stimulus will not in any way be financed by the returns generated by the projects themselves. They will just add to our level of debt.

This is what we have done in Australia, in America, in Europe, in Asia. These are the expenditures that have been endorsed by just about every major economic institution in the world and by economists from almost every branch of the profession. In my view, they simply do not know any better. This is all they know because since 1936 that is all that has been taught.

I, however, come from a different school of thought that was founded on an understanding of Say's Law, classical economic theory and the theory of the business cycle. From this perspective, what has been done is near on insane, will do incalculable damage, weaken our economies and prolong unemployment. Which is why I presented the testimony to the Senate that I did.

This is what academic economists do. They think about things and put their views forward as part of the general debate on what ought to be done. I do think I am right about this and I do think that those who see recovery based on deficit finance are dangerously wrong. But everyone thinks their own beliefs are true so there is no virtue in any of that.

Over the next few years, however, we will find out just who was right and who was not. If everything turns out, well I can find something else to write about for the rest of my career. But should it happen that this Keynesian stimulus has been the international disaster I think it is, then reading what I have written might make clear what needs to be done instead and what should happen the next time our economies enter recession as they inevitably must, just as I think the current recession will end one day, as it inevitably must.

I will finish with an excerpt from a review of my book, Say's Law and the Keynesian Revolution, which I spoke to the Senate about in defence of my own view. This book discusses the history of Say's Law and which, incidentally, explains the origins of the General Theory more accurately than can be found in any other account anywhere else. Don't believe me? Well read the book yourself. And you will see why the reviewer in The Economic Journal, one of the oldest economic journals in the world and amongst the most prestigious, wrote this:

"The original classical formulators of Say's Law never said what Keynes claimed they said. On the contrary, far from dismissing slumps as impossibilities, they stressed their occurrence. They differed from Keynes only in denying that demand failure could be the cause.... A convincing and authoritative account."

Economies are very subtle creatures and fully understood by no one. And as much as anything, it is Keynesian economic theory that is on trial for its life. To repeat what I said at the Senate, Keynesian economics "had been one of the greatest catastrophes for economic theory in the West". In the next year or so, we may all find out just how true that is.

Dr. Steven Kates
for The Daily Reckoning Australia

• The Dead Weight Cost of the Stimulus
• Economic Crisis Discussions in the House of Lords
• David Ricardo is the Dominant British Economist of the Nineteenth Century
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• On the Evidence, Stimulus Programs Aren’t Working

Well, a few people are concerned. Hedge fund manager Peter Thiel told the Wall Street Journal, "The recovery is not real...Deep structural problems haven't been solved and it's unclear how we will create jobs and get the economy growing again -- that's long been my thesis and it still is."

That sounds about right. But is Mr. Thiel's sentiment just sour grapes? Are the bears (your editor included) just cranky because they've missed a powerful six month rally? That's possible, but unlikely.

The real worry is that despite the pages of the calendar flipping over, not much has changed in the last year. The financial system remains fragile. The economy remains addicted to finance. And investors are valuing earnings as if everything was pre-Lehman.

I have rarely been so convinced that the next broader market move is down," says Benjamin Bornstein of Prospero Capital Management in Chicago. "The problem is that governments do not create income or wealth, and current stimulus equates to a future tax liability. That will become a major concern in mid-2010 when the stimulus is done."

By the way, on that subject, the International Monetary Fund agrees. Are you listening Kevin Rudd? The IMF reckons that less than half of the nearly $4 trillion in losses since 2007 have been realised by financial institutions. It says those institutions have to worry about rebuilding capital, stabilising earnings, and borrowing money without a government guarantee.

The Fund also warned that government stimulus programs make life harder for banks because government borrowing sucks away capital from the private sector. "Since all credit providers can buy sovereign debt, sovereign issuance will effectively compete with - and possibly crowd out - private sector credit needs."

Just to recap, government borrowing draws away capital from businesses that might use it to invest in productive projects that generate a real return. What you get in return is higher debt, probably higher interest rates, and people who've never really had to earn a paycheck or meet a payroll deciding how to allocate capital. And you still think it's a good idea?

But let's pretend that government monetary and fiscal policy is not actually making the recession worse and a profitable recovery less likely. For today, let's take up the subject of Aussie banks and the outlook for their earnings. We said that bank capital cushions may still not be large enough to protect them from falling asset values. So having literally rolled up our sleeves, let's get to it.

You might have seen the headline in yesterday's Australian Financial Review, "Cash rich banks ready for growth opportunities." The article claims that Aussie banks are carrying about $6 billion in "surplus capital" which gives them scope, "for expansion and putting them on track to return to record profits in 2010."

Is that so?

It's true that Aussie banks have raised nearly $24 billion in new capital through the equity and debt markets in the last year. And it's true that the big four banks held aside $12.6 billion in provisions for loan losses as of June 30th. But no one knows if that's enough to cushion the banks from another wave of losses.

The consensus view is that since the unemployment rate has (officially) stayed around 6%, loan losses will be less than expected. But we have yet to see any correlation between the Aussie unemployment rate and bank losses. It sounds a bit like saying that because the sky is blue, peanut butter sandwiches taste better.

Aussie banks have booked most of their losses so far on overseas investments related to the implosion in U.S. housing and housing related debt securities. But the future solvency of the banks is dependent on the value of their local loan portfolios. And that brings it down to whether commercial real estate prices and residential housing prices in Australia are really going to escape global deleveraging without declines of at least 20%.

Our view, as you know, is that they can't. If the commercial real estate and housing markets experience large falls, the Aussie banks will be in big trouble, just like banks in Europe and America were when faced with assets that suddenly plummeted in value. In fact, these falling asset values are still taking a hacksaw to the equity of smaller regional banks in the States.

Of course the big banks are not allowed to fail in America. And maybe the very big banks will never be allowed to fail in Australia. But that does not make them a good investment. If you think that other people's mortgages (what the bank calls its assets) are stable and not vulnerable to deleveraging, then we've wasted your time today.

We promise to make up for it tomorrow by telling you why gold stocks are horrible investments but world-class speculations. It's the antidote to Ponzi finance.

Dan Denning
for The Daily Reckoning Australia

• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• One in Four US banks Announce Unprofitable Quarter
• IMF Report Concludes Aussie Banks are “Very Sound”…
• Government Preparing Another Stimulus
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit

"We may now be entering the Asian century, dominated by a rising China and its currency. This decline of the dollar might take more than a decade, but it could happen even sooner if we do not get our financial house in order. The United States must rein in spending and borrowing, and pursue growth that is not based on asset and credit bubbles. For the last two decades America has been spending more than its income, increasing its foreign liabilities and amassing debts that have become unsustainable."

Yes, it could take more than a decade. But investors could take a big loss any day. All it would take would be a sudden move by China...or a shocking inflation figure in the United States...or a Treasury bond auction that doesn't go as planned. Everyone is watching the United States...carefully. And foreigners hold trillions' worth of dollar- based assets outside the United States. These are dollars that people hold, not to pay their bills or buy gasoline, but as a speculation. They're speculating the greenback will hold its value as well or better than the other things they might do with their money.

Europeans hedge their bets against the euro - with dollars. Asians hedge their bets against falling stock prices. Russians hedge their bets against the ruble. Latin Americans hedge their bets against their own pesos, bolivars, and cordobas. Everybody likes dollars because they are the most trusted money in the world. For the last 50 years, nothing could compete with the dollar. (Even though the dollar lost value against a number of other currencies over long periods of time.)

These foreign holders are already nervous. They've seen the mess the United States has gotten itself into. They read the headlines. They watch the news. They know that the United States is running a budget deficit this year equal to four times the biggest budget deficit ever - a record set just last year. It is as if a runner broke the record in the 100-yard dash...and then ran the course four times faster a year later. This is not progress. This is spooky.

The Chinese already let the United States know they are worried.

"We trust you to protect the value of our assets," they in essence said to the US Treasury Secretary.

And in the middle of May 2009, from the Financial Times comes news that Brazil and China are working toward using their own currencies in trade transactions rather than the US dollar.

This comes on the heels of the news that China's central bank governor Zhou Xiaochuan proposed to create a reserve currency "that is disconnected from individual nations."

What Mr. Zhou would like is to replace the US dollar as the world's leading currency with a new international reserve currency, possibly in the form of special drawing rights (SDRs), a unit of account used by the International Monetary Fund.

Then in June, Russian President Dmitry Medvedev questioned the US dollar's future as a global reserve currency and said using a mix of regional currencies would make the world economy more stable. Russia may consider ruble-yuan swaps.

The dollar "is not in a spectacular position, let's be frank, and its prospects cause various questions as do the prospects for the global currency system, " Medvedev said in an interview published by the Moscow-based Kommersant newspaper. Regarding the global financial system, "therefore our task is to make it more mobile and at the same time more balanced."

But for now, as long as these countries trust the United States to keep its promises and protect its money, they continue to hold US dollar investments - notably, US Treasury bonds. But just wait until the United States loses their trust. In a matter of minutes, China could dump enough US dollars to set off alarms all over the world. All of a sudden, dollar holders would rush for the exits - each one trying to get out before the others. In minutes, the dollar market could collapse...taking down US Treasury bonds with it.

Regards,

Bill Bonner and Addison Wiggin
for The Daily Reckoning Australia

• The Greenback Dollar Decline
• US Dollar As Reserve Currency Not Working Very Well
• US Dollar a Sort of Monetary Brand
• 4 Ways to Protect Against a Falling Dollar
• Special Drawing Rights Used as the World’s Reserve Currency?

Apparently the current set-up of having the US dollar as a reserve currency isn't working very well.

They're quick learners at the UN obviously!

Their report makes some of the right noises, "The dollar-based reserve system is increasingly challenged." Hmm, a slight understatement there. If "increasingly challenged" is a euphemism for "dead" then we'd agree.

But we don't think that's what they mean.

So, what do they plan replacing it with?

Special Drawing Rights, or SDRs. If you've got no idea what that means, it's simple.

An SDR is something made up by the boffins at the International Monetary Fund (IMF) to act as an "international reserve asset."

The rationale for the creation of the SDR was that "the international supply of two key reserve assets - gold and the US dollar - proved inadequate for supporting the expansion of world trade and financial development that was taking place."

Look, your editor won't pretend to be a grade 'A' student of monetary theory, but to us the creation of the SDR is part of the reason the global economy is in the current mess.

That gold was deemed to be inadequate for "supporting the expansion of world trade and financial development" tells you that's when the Western world begun its massive spending spree.

Back in 1969 with the creation of the SDR.

A spending spree that couldn't be achieved just through stealing money from citizens through the tax system, but one which could only be kept going by the creation of more money.

It was, you could argue, the beginning of the 'consume, don't produce' Western economies.

The problem that SDRs 'solved' was the ability to crank up the printing press. Of course that didn't happen straight away. There's always a transition with these things.

First, as it happens, like the US dollar, the SDR was backed by gold. But if you're creating a new reserve that you want to be more flexible than gold (ie. You want to print more money and spend it), then backing it with gold isn't going to work.

Because backing a currency with gold helps to maintain the value of the paper currency. If you know that your $1 note is redeemable for a set quantity of gold then it will maintain value.

It means the banks can't - or shouldn't - create more paper money than the reserves they have in gold to back it up.

Simply put, it creates and requires discipline. Something that bankers and governments in the 1960s weren't happy with. The 'inflexibility' of gold makes it harder to for governments to spend and makes it harder for banks to lend.

Therefore the creation of the SDR was a stepping stone to abandoning the reserve status of gold. And sure enough, four years after the SDR was invented, US President Richard Nixon closed the gold window at the Federal Reserve and there was no longer any obligation for US dollars to be exchanged for a fixed weight of gold.

Instead the US dollar was backed by nothing, and so the SDR was backed by the US dollar and other currencies which were also backed by nothing.

Yet it is this 'worthless' SDR which is being touted as the new reserve currency.

But why should the SDR make any difference? It won't. An SDR is just a weighted basket of other currencies. Unless it is backed by something tangible, such as gold, then it will prove to be equally as worthless as the US dollar it is replacing.

Perhaps, bankers and governments will see the error of their ways and make a call for these new SDRs to be back by gold...

Not a chance.

There are several reasons for that. One, as I mentioned above, is that gold forces a government and its central bank to be disciplined. It cannot circulate more money without having a corresponding increase in its gold reserves.

If it were to do so then the paper money - or certificates - would not be fully backed by gold. This would cause the value of the paper to decrease - the greater supply of one thing relative to another devalues it.

If people got wind that the central bank was printing more money without increasing its reserve of gold, there would be an increased demand for physical gold. There would be a run on the banks.

The other problem gold has is an image problem. Take this comment from a recent article by Alan Kohler over at Business Spectator:

"But while there's no doubt the gold will continue to be underpinned by the demise of the dollar, it is not a currency. I can't go into JB Hi-Fi with a lump of it and buy a TV."

"Central banks around the world own about 26,000 tonnes of it, which represents 8.5 per cent of total reserves, but it's not legal tender. It's just a commodity they got stuck with because it used to be a currency a long time ago and will never be again."

It's fairly common of the attitude the mainstream press has to gold. They don't understand that it is a store of value.

Kohler claims you can't go into JB Hi-Fi and buy a TV with a lump of gold. He's quite correct on that score. But it wasn't so long ago that is effectively what consumers did. Maybe not for TVs but for other items.

Under a gold standard where your dollar was backed by gold, consumers were exchanging a gold backed dollar for goods. It was an exchange of gold for goods, only that a paper note was used as a proxy.

What's so crazy about that? Nothing.

But if you look at Kohler's other comment about 26,000 tonnes of gold being only 8.5% of total reserves it gives the game away for the real reason bankers and governments don't want a gold backed currency.

Inflation.

It's no coincidence that since the early 1970s global paper currencies have lost about 90% of their value. Virtually every currency you name is worth significantly less today than it was thirty-odd years ago.

That's not because prices have risen, it's because currencies have become devalued.

As Kohler, perhaps unwittingly admits, central banks and governments have embarked on a massive money printing exercise.

If paper money still had the backing of gold then global economies would not have one-tenth of the current problems we are currently facing.

The fact that the UN and other government organizations are proposing to replace one currency backed by nothing with another currency backed by nothing signals they are either ignorant or are intentionally pursuing policies guaranteed to deliver economic destruction.

And more importantly to you, to guarantee the continued devaluation of your money and wealth.

Kris Sayce
for The Daily Reckoning Australia

• US Dollar Declining as China’s Currency Rises
• Special Drawing Rights Used as the World’s Reserve Currency?
• An International Currency Not Just on Paper
• A Gold Standard, Without Gold
• The U.S. Dollar vs Inflation, Americans Vote for the Dollar

It's back to business. No more long lunches. No more afternoons painting windows. No more soirees in the evening.

We return to our lonely métier - chronicling the decline and fall of the US economy...and the Anglo-American empire too....

Two bits of news signal the scale of this trend. But first, here's one two-bit piece of news: the Dow lost 185 points yesterday. Could this mark the beginning of the end for the rally? Yes, it could. Should you be out of US stocks? Yes, you should.

But let's turn back to our 'decline and fall' chronicles...

From Florida, comes news of the first drop in population in 60 years. "Unemployment is soaring," reports USA Today. "Florida is second to California on foreclosures."

Yes, dear reader, there is trouble in the sand states...

Florida lost a net 58,000 people this year...for the first time since the 1940s.

Why would that be? We'll take a guess. Florida is a state where people go to retire. It is where people go when they stop producing and begin consuming. The major industry in the state was housing...building houses for consumers!

But now, the turn has come. Fewer people have money to consume. And those who do are keeping their money in their pockets. We even saw a report in The Wall Street Journal that people are cutting their own hair to save money. They're also staying put, rather than moving to Florida. So Florida needs fewer new houses...and fewer people to build them.

Second, from national income statistics comes a report that the typical US household has less discretionary spending than at any time in the last 50 years. Why? Americans have no money to spend because they already spent it! Now they're paying the price. And it will take years - maybe 10 years, maybe longer - before they've paid down their debts to more comfortable levels. In the meantime, they are poorer than they've been since the Eisenhower years.

Keeping it simple: Our view is that there is a major transition underway. There will be no genuine recovery, not now...not never. That is not to say the world economy is doomed to perpetual darkness and misery. Not at all. What it's doomed to is a long period of adjustment...with high unemployment, on-again, off-again recession, and desperate efforts by the feds to return to the good old days of the bubble years.

But there's no going back. It was as if the economy was playing a game of Russian roulette...and then the pistol went off - the debt bubble blew up. Once the bullet left the chamber, the game was over. Recovery? Forget about it. The old economy isn't going to bounce back; it's dead.

Still, just because a thing is hopeless doesn't make it unpopular. The feds are fighting the correction every step of the way. They're propping up brain-dead companies...and keeping zombie banks going by feeding them the blood of taxpayers. It's ghoulish...it's a very scary movie!

Unfortunately, the ghouls vote! And everywhere the feds look there's a campaign contributor or a lobbyist or a voter...and they all want the A-positive blood of taxpayers. They look to the feds for a transfusion in order to keep living in the style to which they've become accustomed...

Just what you'd expect, in other words. And with so much debt in the system, the feds are desperate to raise inflation levels. They must increase the CPI to persuade consumers to spend money rather than save it. Otherwise, the nation risks falling into a deflation trap - the very thing Ben Bernanke has pledged to avoid. So they'll continue going down that road - towards inflation - until they finally get there. And they'll keep pressing harder and harder on the monetary accelerator until they finally run into a tree. Again, just what you'd expect.

So, where's the surprise? We're on the road to destruction; that's clear. But it may be a much longer road than most people expect.

Ambrose Evans-Pritchard in London's Telegraph:

"'The current financial crisis is unlike any others,' says the Bank for International Settlements. Lasting damage has been done. The 'cumulative output loss' is likely to reach 20pc of GDP in the major economies.

"The message is the same at the International Monetary Fund. 'The world is not in a run of the mill recession. The crisis has left deep scars. In advanced countries, the financial systems are partly dysfunctional,' said Olivier Blanchard, the Fund's chief economist.

"It has certainly alarmed US retail tycoon Howard Davidowitz. 'As a country we are out of control, we're in a death spiral,' he said.

"Jeff Wenniger from Harris Private Bank says an army of baby-boomers have seen their old age plans shattered by the housing bust. Their nightmare is here. They will have to spend less, and save more. 'Generational destruction of a society's balance sheet will not rectify itself in a matter of months.'

"'How about a quarter century?'"

Bill Bonner
for The Daily Reckoning Australia

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The subprime collapse is one symptom of years of little regulation, under-taxing, overspending, and massive debt. One way to understand what is happening in the United States is to look at what occurred time and again in Latin America and Asia, hotbeds of financial and banking crises. What we are living through happened time and again in Brazil, Argentina, and Mexico, as well as Korea and Thailand.

If there is too much debt, people lose confidence in the banks, then credit markets, currency, and government.

For more than a decade, the international financial cop, the International Monetary Fund, forecast a hurricane was heading toward US shores. As did many heads of the Treasury and the Fed. It is, to paraphrase a great writer, a chronicle of an agony foretold. There are five basic drivers of these crises, all based on excess: high income concentration, too much debt, too much reliance on foreign money, not enough tax revenue, and reckless government spending. Time after time governments believe they are different. They are bombarded by warnings but ignore, postpone, spend even more, and crash.

Over past decades, most US wages have fared poorly. Despite stagnant wages, consumer spending and debt increased, fueled by cheap credit. Companies also went on a debt binge. Careless deregulation allowed financial cowboys to run the system. Responsible CEOs who kept some cash, maintained moderate debt, invested for the long term, got pink slips. Financial chop shops did leveraged buyouts using a company's own cash and credit. To survive, companies piled on debt.

Many politicians decided reelection depended on cutting taxes and offering more benefits. Increase Medicare, postpone Social Security reform, hire more bureaucrats, and pay for a two-front war. Debt grew to pay for this party. These were not true tax cuts, just postponed debt; now we owe more and the bill has come due with interest.

Complicating this crisis is US economic hegemony. There were few places to park a lot of money. Despite the euro, European policies on debts and deficits are not much to brag about. So foreigners have gorged on US debt. The United States continues importing more than it exports. Middle Easterners and Asians who save and invest bought dollars for decades, but some of this money is now fleeing. The dollar has dropped sharply. Gold and oil have skyrocketed. In financial crises, huge pools of capital cross borders very quickly; a few can make a great deal of money shorting the country's currency.

The United States requires a massive restructuring to address its debt, cutting back on its borrowing, spending, and wars. The bailout package is essential to keep the credit markets open. But absent sentences that include the word austerity all the bailout will accomplish is a temporary postponement. Bailout and stimulus are a stopgap.

A solution requires the country to begin to spend what it earns, reduce its mountainous debt, and address massive liabilities, restructure Social Security, pension deficits, military, and Medicare. No wonder politicians would rather spend more of your money now rather than address these problems. Because we have been spending 5 to 7 percent more each year than we earn, a forced restructuring, triggered by a currency collapse, would have the same effect on wages and purchasing power that the housing collapse had on housing prices. So let's learn from our Latin and Asian friends and act before it is too late.

Regards,

Juan Enriquez and Jorge Dominguez
for The Daily Reckoning Australia

• Latin America Has Suddenly Become Very Interesting
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• Investment Banks Making Money Thanks to US Government Bailouts
• US Dollar Declining as China’s Currency Rises
• From Bubble Watch to Bust Watch

I can tell by the way you are not screaming in fear and frantically clawing your way to the nearest exit in a generalized panic that you do not know what a Special Drawing Right is. So prepare to scream and claw when I tell you that - according to the Economist magazine, which I cite as a source since you never believe anything I say - an SDR is "a synthetic currency created by the IMF, whose value is determined as a weighted average of the dollar, euro, yen and pound"!

I deliberately put that exclamation point there at the end so that Junior Mogambo Rangers (JMRs) around the world and across this quadrant of the galaxy would not miss the salient fact that there is something Really, Really Weird (RRW) when these Chinese bastards are smart enough to reject an over-valued fiat dollar, but then being so stupid that they prefer, over gold, a basket of four fiat currencies, one of them being the damned dollar, along with their four corrupt governments, which collectively own the IMF by virtue of having funded the damned thing in the first place! Hahaha! Brilliant! Hahaha!

By this time I was laughing so hard that my stomach started hurting, which made me think that maybe I was hungry, and how maybe a taco would hit the spot right about now, which is Mexican food, as I suddenly suspected Chinese food for making them sound so ridiculous.

So my mind was whirling, whirling, whirling with many thoughts as Zhou went on to say, "Therefore, efforts should be made to push forward a SDR allocation. This will require political cooperation among member countries", which (as I understand it) means that governments should stand ready with their armies to lend a hand to fellow governments around the world with the unpleasant task of killing rebellious civilians who will inevitably riot when they run out of food because they cannot afford to buy food because the damned American government is still deficit-spending, but now measured in the trillions of dollars per year, a demand met with excessive amounts of new money and credit created by the Federal Reserve, increasing the money supply, which in turn creates inflation in prices.

As usual, I get no feedback from the Chinese, perhaps thanking me for saving their economic butts by pointing out where they have been so stupid as regards this "gold money" thing by, you know, sending me a couple of tons of it, or even a fruit basket would be nice, ya know?

So, I figure that their ignoring me means that maybe they have discovered, with their famed espionage networks, that I am not the world-famous guy I say I am ("They call me Big King Mogambo (BKM) back home!"), but am just some sort of mental case or something, usually described by the newspaper as "local lunatic."

So I figure that maybe someone of the stature of Bill Bonner here at The Daily Reckoning would have the desired impact, and so I tell them how Mr. Bonner writes that "one way or another...sooner or later, a new money system is bound to emerge. Most likely, it will have gold at its base. Why? Because in thousands of years of human experience, nothing better has ever been found."

Well, normally, you would expect someone being told that nothing better than gold has been found that could be used as a store of value to suddenly slap themselves on the forehead ("Ow!"), and say "Hey! You're right! Nothing has worked better as a long-term investment than gold, and so anything other than gold is a bad investment when the governments of the world are deficit-spending at record rates and the money supplies are expanding at such preposterous rates that the sheer volume of money sloshing around allows interest rates to be temporarily lower than the real rate of consumer price inflation, which is a condition that is so freakishly insane that just thinking about it should make synapses in your brain burn to a freaking cinder with an audible 'ssss!' when you comprehend the enormity of it!"

So, suddenly, you know something is wrong, and a chill overcomes you, when, even more mysteriously and spookily, the Chinese central banker says, "The scope of using the SDR should be broadened, so as to enable it to fully satisfy the member countries' demand for a reserve currency"!!!

The three exclamation points indicates that I am on Full Mogambo Alert (FMA), as I now know that Chinese bankers are as duplicitous as all the others; he is proposing to create as much SDR money (which is just another fiat money composed of the fiat dollar, the fiat euro, the fiat yen and the fiat pound) as anyone in the world wants! Which is the problem that got us into the mess we are in, for crying out loud!

Even more bizarrely, he states some ridiculous benefit of, "Compared with separate management of reserves by individual countries, the centralized management of part of the global reserve by a trustworthy international institution with a reasonable return to encourage participation will be more effective in deterring speculation and stabilizing financial markets", which means that no country will have any reserves at all, and some mysterious "trustworthy country" acceptable to China means that China will hold all of the reserves, and therefore be calling the shots of the new currency, and since nobody has any reserves, they will be under complete control of the IMF, which will be under the control of China! Gaaaahhhh!

Well, you know I must have hit a nerve, because they don't answer me and thus quell my howling outrage and fear from even contemplating such a scary thing, and instead, they go on "The participating countries can also save some reserve for domestic development and economic growth", which makes you go, "Huh? What in the hell are you talking about keeping 'some' for our own use? What else would I be using it for, you stupid putz?"

Then I realized that this kind of crap leads directly to a pertinent lesson on why you should be buying gold, silver and oil so as to save your Fine Financial Fanny (FFF), but there are so many reasons that I groan with dismay at even listing them all.

Until next time,

Mogambo Guru
for The Daily Reckoning Australia

• The Destruction of the Dollar by the Federal Reserve
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"And now nothing shall be withheld from them which they have desired to do..." I mentioned this quote several weeks ago. It comes from one of the many attempts that foolish men have made to be as God. It also brought about one of the greatest cataclysms in history. You can read the whole thing in Genesis 11.

For us, it applies heavily to the advances of government into the field of business. It only makes sense: the occupants of the White House and the Capitol have done such a good job with their budgets over the years, they just want to help everyone else (over the cliff, that is).

It began, as it always does, with just the camel's nose in the tent. A bit of money here, some bank guarantees there. But then, as the fable tells us, the rest of the camel wanted in.

The government insisted on foisting money on companies that didn't even need it. Washington's excuse? If the only companies taking the money were the ones that needed it, those companies would suffer a "stigma." But if every company took the money, even if they didn't need it, the bad ones couldn't be singled out.

We, of course, would never know the difference between the two. So much for more transparency in government. Now the companies who didn't need the money are lashing back. Having to pay 5% interest on money they didn't need to borrow is only a greater liability to already burdened companies.

But the government's fun still wasn't over. It forced out a CEO at AIG, now one at GM... and it passed a stimulus plan that required contractual bonuses be paid, then issued a 90% tax on them when the public outcry became too great.

Now Chrysler is being pressured to bring green cars to the market by none other than their new "boss," the Obama administration. Of course, they already have a green car, but the "boss" says it's too expensive for the public to afford. So, essentially, he pulled the plug on it. Frankly, I'd like to know why he thinks that Chrysler's greenie is too expensive. It certainly could not cost more than the bailout price tag they have forced each of us to shoulder. Expensive is a relative term.

Make no mistake about it, we are living in times that will likely produce great changes in the world. There is a certain theory that attempts to explain the history of the world through great cataclysmic events.

Some are occurrences in Nature; some are wrought by the folly or the genius of men. Let me say at the outset that I am a subscriber to this philosophy, so have no illusions about what I am saying.

Actually, most people who ever think about such things believe that all of existence began with a great cataclysm. You can call it the "Big Bang" - no matter if you're referring to the "Big Bang" that set the evolutionary process in motion, or the "Big Bang" of God creating the heavens and the Earth.

At some point, life came into existence - a big event in the universal process of all things. Of course, this is the point where the two theories begin to diverge from one another. Evolution has no more "Bangs" left in its bag. It is a slow and relatively even process from there on. Which is, I suppose, why it takes them billions of years to get to the point that God was able to accomplish in six days.

But for the recorded history of men, it has been one cataclysm after another, of varying sizes and types. Famines, floods, pestilence, earthquakes, volcanoes... and other natural disasters take their toll, but seem to always right themselves over time.

The follies of men, however, are a different matter.

The wonderful world of economics is no exception, and has no exemption. As I have said before, economics bears within itself the very principles by which God has made it to be governed. The Law of Supply and Demand is not dependant upon Congress. It was not invented by the whim of elected or appointed regulators. It is not governed by the United Nations, the International Monetary Fund or the European Union.

It brings to mind a letter someone once sent to Congress. Perhaps you've heard about it before. If not, please enjoy:

Senator John W. Bricker

The Senate

Washington, D.C.

Dear Senator Bricker,

In my opinion I would suggest that if the Senate and Congress would abolish that awful law of supply and demand, it would increase production. Stop hoarding for high prices as is now being done by the government and others. Push all products for sale to the markets and start competition. The law of supply and demand is a burden to the Consumer because they foot all of the bills.

I trust you and your fellow senators and congressmen will act promptly.

Gerald V. __________

(Taken from Dear Mr. Congressman, by Juliet Lowell {New York: Duell, Sloan, and Pearce, 1948}, p. 91.)

I suppose we ought to give Gerald high marks for even knowing the term "supply and demand," since I tend to think you might be hard-pressed to find it in the vocabulary of modern high school students. I have long felt that it would be a good question for Jay Leno's "Jaywalking" segment of the Tonight Show.

At any rate, the laws of economics are established by a much Higher Power than we will ever be. And while we are at it, we should also understand that the Power is stronger than we can ever successfully contend with.

This is why, try as we might, we cannot substitute our own economic devices and have them succeed.

So let's put a finer point on all this. The value of a nation's currency is built upon the honesty behind it. Even a currency backed by gold becomes worthless if the government holding the gold cannot be trusted. While in days gone by it was easier for authorities to debase a metal and get away with it, all such obligations now are simply based on a government's willingness to part with its gold. Of course, these days it does not happen.

And while the United States has been an expert in telling other countries how to morally treat their people, we have been robbing them blind! It has gotten so bad that even the Evil Empire and the Red Menace have seen through our chicanery. We may look upon them as people less "evolved" than we are, but the jig is up. Our hypocrisy has been found out.

We have become like the man in the Biblical parable who tried to remove a speck from the eye of his friend, when he himself had a log in his own eye. "First remove the log from your own eye, and then you will see clearly to remove the speck that is from your friend's eye." Seems like pretty simple (and common-sense) advice. But in the words of newspaperman Horace Greeley, "Common sense is very uncommon."

I began this by saying that cataclysmic times are upon us. We are seeing the shaping of men and nations. We are setting the groundwork for the impoverishment of generations.

Spain fell in line with the prevailing models of economics by bailing out its first bank in a quarter of a century. And with a broad brush it painted its regional banks as "heavily exposed to property developers struggling during a deep recession."

I have told you often of the difficulties prevalent in Europe. Here is but one more piece of evidence. Authorities are planning to solve this with 2-3 billion euros - but, oddly enough, have promised up to 100 billion euros. Wow! That's a huge disparity. I believe they may think it will take more than just 2 or 3 billion.

On the same topic, European Central Bank President Jean-Claude Trichet sees more ongoing deterioration all across the Eurozone. Market forecasts believe Brussels will announce a 50-basis-point rate cut later this week. Germany, which makes up about 25% of the euro economy, is looking for an acceleration in economic deterioration.

This is a cataclysm.

Central Banks are flying blind with an instrument panel that has no configuration for the geography. The fixes they are trying will lead us to Zimbabwe (hyperinflation) or Tokyo (perpetual slump). Pick your poison.

In the meantime, I am forced to look for more overall dollar strength. The United States still possesses the deepest markets and the "deepest pockets" in the world. If other economies continue to fail, fiat currency supply and demand will favor the dollar. And by "deepest pockets," I mean they are committed to inflating their way out - and have more ability to do so than anybody else.

I know looking for dollar strength seems a little backward while they are inflating. But the truth is, ever since the credit crunch, everything has been turned on its ear. If you are new to the currency markets, say within the last couple of years or less, likely most of this action makes very little sense to you. But in these times we must remember this axiom: The market will eventually adjust to actual realities. In the meantime, it will be moved by perceived ones. As long as fear filters through the markets, the currency flows will come back to the dollar. When there are periods of vacillation between fear and risk, the currencies can swing wildly.

Regards,

Bill Jenkins
for The Daily Reckoning Australia

Editor's Note: Bill Jenkins, founder and managing editor of Master FX Options Trader, knows the Forex currency markets inside and out. After 20 years and a string of losses following other people's crack advice, Bill created his own system for cashing in on tiny currency fluctuations between the British pound and the U.S. dollar.

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"If, on the breaking out of any future war, we shall not have very considerably reduced our debt, one of two things must happen, either the whole expense of that war must be defrayed by taxes raised from year to year, or we must, at the end of that war, if not before, submit to a national bankruptcy; not that we shall be unable to bear any large additions to the debt; it would be difficult to set limits to the powers of a great nation; but assuredly there are limits to the price, which in the form of perpetual taxation, individuals will submit to pay for the privilege merely of living in their nation country." (Ricardo, Principles, Ed. Straffa, p.249).

Gordon Brown has no intention of embarking on a new war, though he has defence commitments in Afghanistan, but he has failed to foresee that a large deficit makes it more difficult to support future deficits. They will be harder to meet by borrowing and they will result in levels of taxation which will discourage enterprise and possibly lead to migration.

On page 356 there is the statement on which the nineteenth century gold standard was based:
"Experience, however, shows that neither a State nor a Bank ever have had the unrestricted power of issuing paper money, without abusing that power; in all States, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose as that of subjecting the issues of paper money to the obligation of paying their notes, either in gold or bullion."

Under the gold standard, national governments had to regulate the issue of money by the discipline of convertibility into gold. William Stanley Jevons published his book on Money in 1873 - 58 years after Ricardo. He quotes Daniel Webster's observation about the U.S.: "We have suffered more from paper money than from every other cause or calamity. It has killed and caused more injustice than even the arms and artifices of our enemy." Jevons also observes, in his own right: The principle objections to "inconvertible paper currency are two in number,. 1. The great temptations which it offers to over issue and consequent depreciation. 2. The impossibility of varying its importance in accordance with the requirements of trade."

The essential qualification of an exchange system in classical Ricardian economic theory is therefore one of convertibility. The value of a currency is determined by its relative scarcity, and its relative scarcity is determined by its convertibility at a fixed rate into a fixed commodity; the Victorian economists regarded gold as the most convenient commodity, and the one which had the nearest to a stable rate of production.

There is a growing feeling that the present economic crisis requires a stabilisation of national currencies against some sort of world currency. The Chinese Government is interested in a world currency system such as Maynard Keynes advocated at Bretton Woods in 1944. The Russians have called for a partial restoration of a gold based system. In The Daily Telegraph of March 30th, Ambrose Evans-Pritchard reports that Arkady Dvorkevich, the Kremlin's Chief Economic Adviser, has stated that Russia "favours the inclusion of gold bullion in the basket-weighting of a new gold currency based on 'Special Drawing Rights' issued by the International Monetary Fund."

Historically, the world has moved in the course of a century from the pre-1914 gold standard, which was a system of classical discipline based on convertibility into gold, through a succession of floating rates, with the ultimate American convertibility into gold broken in 1971. As Jevons observed, an inconvertible floating paper money is in practice extremely liable to over-issue, leading to inflation. In the absence of convertibility at a fixed rate, a currency degenerates into mere paper. The Russians are the second largest gold producer, and are also major oil and gas producers. Naturally, they would like gold to play a part in any bundle of assets on which a new world currency might be based. We are in an early stage of a new exchange debate. What is interesting is that the debate has started with big power participation from China and Russia.

William Rees-Mogg
for The Daily Reckoning Australia

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