But let's start with sovereign wealth fund of China, the China Investment Corporation (CIC). CIC was set up in 2007 with US$200 billion of China's nearly $2 trillion foreign exchange reserves. It's been shopping ever since, with mixed results. Last year, for example, CIC stood pat and only invested US$4.8 billion outside China. It preferred to ride the bubble in Chinese bank stocks, which worked out pretty well for it.

Yesterday, however, Reuters reports that CIC is now cashed up to the tune of $300 billion and ready to buy again. "It will not be too bad this year," says CIC chairman Lou Jinwei. And here's the good part. "Both China and America are addressing bubbles and we're just taking advantage of that. So we can't lose...We have to be in everything because you never know what's going to happen in this world."

Come again?

There's a charitable way of reading these comments and there's a straight forward way. The charitable way is that Lou and the rest of China's economic mangers know that their $2 trillion in forex reserves (which are mostly in U.S. dollars) are in perpetual danger of devaluation. If you had a pocket full of $300 billion in monopoly money, trading it for anything-anything at all-would be the sensible strategy.

You'd want to trade it for a real tangible assets or equity before asset sellers started treating your money with disdain. This is why CIC "can't lose." Better to trade it for something now then watch it turn into nothing later.

The straightforward interpretation is that the Chinese wealth fund managers have lost their marbles. Counting on more bubbles to increase your wealth is a portfolio destruction strategy. Chinese fund managers may end up being every bit as stupid as the hedge fund managers and bankers and CEOs at U.S. banks who ran their respective institutions into the ground making the worst leveraged bet of the century on U.S. housing.

The only real difference, as far as we can see, is that the U.S. bets were made with borrowed money (often borrowed from Chinese creditors, we reckon), whereas China is investing the fruits of its productive labour over the last twenty years. It is a massive gamble. The U.S. managers, who may have been criminal rather than stupid, did tremendous damage to their country's economy. Will China's managers replicate the feat?

This also makes you wonder how much the emergence of China itself is a function of a global bubble in fiat money since August of 1971, when Richard Nixon took the U.S. dollar off the gold standard. Sure, there are tens of millions of Chinese people working in real factories making real products out of real raw materials (many sourced in Australia). These people have real dreams, ambitions, and economic aspirations, not to mention real savings (in gold and paper money).

But is it possible that China's time at the centre of the global economic stage is limited because China's economic model itself always depended on cheap credit and fiat money? Yes, yes. It goes against the whole "next economic empire" way of thinking. But if China's official asset managers are counting on bubbles to make them wealthier, you wonder how sound the model is, and how long the wealth will last. We wonder anyway, which is our main job at the DR.

Empires. They sure don't make them like they used to. Rome lasted a good long while, with a big lead up as Republic. The 1,000 year Reich didn't last ten years. The economic and political clock seems to be speeding up these days.

That would be something. A twenty-year global boom from fiat money that simply accelerated the depletion of natural resources and the misallocation of capital to projects that are uneconomic at lower levels of household and business debt. Hmmn.

Speaking of resources, two notes that prove oil is still out there, but getting harder to find and more expensive to produce. PetroChina will spend $2 billion to buy a 60% stake in the MacKay River and Dover oil sands projects in Canada's Athabasca oil sands. Canadian sources reckon there are 5 billion barrels of bitumen on the properties. But turning bitumen into oil isn't easy or cheap. It takes lots of water and energy, neither of which are money.

The other note is that BP says it has found as much as three billion barrels of oil in the Gulf of Mexico. It found it by drilling 10,685 metres below the Gulf of Mexico, or 35,000 feet. So BP drilled the equivalent of a Mt. Everest underwater to find the oil. Actually, Mt. Everest plus another six thousand feet.

This is ample evidence of Peak Oil. It shows that oil is getting harder to find and more expensive to produce. Technology has improved, of course, allowing exploration companies to look further afield than ever before. Oil companies can increase reserves this way. They're finding oil. But it is not the cheap, easy, free-flowing stuff once found in the oil fields of East Texas or Saudi Arabia.

By the way, if you're wondering what could cause a second dip in the global recession, we have an answer: government stimulus. Yesterday was full of stories on how the stimulus spending by the Australian federal government made the recession less worse than it might have been and produced positive GDP growth. This has everything backwards, although it's being swallowed whole by the financial press.

A rebound based on monetary inflation and government spending isn't a real rebound at all. It gives the appearance of normalcy and economic health through rising asset values and more transactions in the economy (which GDP itself measures). But unless there's a big pick up in private investment, the economy is not on any sounder long-term footing.

In fact, it's worse. The illusion of prosperity created by stimulus spending induces people into maintaining debt loads they might otherwise reduce. Consumption patterns which ought to change in order to put the household and corporate balance sheets back in working order aren't changed at all. And when the government stimulus is withdrawn later---as it must be before higher fiscal deficits lead to rising interest rates-the economy reverts back to its pre-stimulus levels of growth-only without the underlying issues of over consumption and too much debt having been addressed.

Or the short version: there is no easy way out of this mess. The government can't create wealth by borrowing money or taxing people and spread the lucre around to favoured groups at the expense of others. That's theft and it's immoral. But the real issue is that the whole economy needs to reduce leverage. The housing bubble has to pop. And the nation has to quit living above its means (we remember writing this about America five years ago).

How about some reader mail?

Hi Dan,

Gene A.

Not this first time we've heard this and won't be the last. We write about outliers and Black Swans. Those topics are controversial, which is why the mainstream media is afraid to express a real idea about them. What's more, getting people's attention in this economy is tough. Sorry you don't like the ads. But don't expect them to change.

For one, we have to pay the bills. As much as we like writing the DR, there's an entire publishing operation to support that provides research to paying subscribers. Secondly, we wouldn't describe any of our publications as "loopy get-rich quick schemes." We know how much time and research goes into each monthly report. We stand behind all the ads and have a hand in a fair a few of them to make sure they're telling the stories we think you can profit from. If you really don't like them, you can always just ignore them.

--Hi Dan

Aidan

--DR

John

Dan Denning
for The Daily Reckoning Australia

• The Iron Ore Pricing War Between China & Australia
• China, the Miracle Economy
• Inflation: Enemy Number Two
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• India Beats China to Walk Away With 200 Tonnes of IMF Gold

So how does she quantify "relative peace and security"? Well, one good way is to look at the value of the dollar, which would be strong if the country was a good investment, which it was, and in fact, "It had not only retained one hundred percent of its value, it had gained eleven percent. That's right. The dollar we started with in 1776 bought us eleven percent more after almost seven generations."

Then, on the "quiet 23rd of December in 1913", J.P. Morgan and buddies got Congressional quislings to pass legislation authorizing the creation of the Federal Reserve, and to which I add that the jerk Woodrow Wilson then signed it, thus going down in history as the disastrous guy who set in motion the destruction of the dollar by the Federal Reserve creating excess money and credit.

She doesn't make a point of it, but back then, the dollar was still gold, and thanks to the loathsome Federal Reserve creating the money to finance the bubbles of The Roaring Twenties that resulted in the Great Depression, the despicable Supreme Court infamously ruled in 1933 (and upheld by every traitorous Supreme Court case since then) that, contrary to what the Constitution said, the dollar did not have to be made of silver or gold, and that a paper "fiat" currency could be created, without limit, for any reason, even at a mere whim, anytime, day or night, 24/7, including holidays, not realizing that they were the idiots that REALLY destroyed the dollar! Gaahhh!

With this kind of disastrous stupidity, I dryly and humorlessly ask that you don't talk to me about any "wisdom" emanating from the Supreme Court.

I was hoping that Ms. Lilley would spontaneously pick up on the theme of "heap scorn on the Federal Reserve for creating too much money and credit out of thin air and the despicable Supreme Court for letting them."

I was going to suggest that she could, you know, maybe even put in an endorsement for the Mogambo Mindless Mob (MMM) brand of products, like the popular Mogambo Pitchfork (very effective when brandished threateningly) and the classic Mogambo Flaming Torches that will be so hard to get when the proletariat bozos start forming mindless mobs bent on revenge after so much hurting from the horrifying inflation in consumer prices, the pervasive, lingering economic depression, ruination, bankruptcy and the embarrassment of realizing that it was caused by the people we elected to Congress, who picked the people to run the Federal Reserve, which is the biggest failure one can imagine and should be immediately abolished, how Ben Bernanke, its chairman, should be turned over to me for some sessions at my new Mogambo Re- Education Center, where our muscular, trained technicians will slap the hell out of his stupid face, and the stupid faces of Congresspersons (except Ron Paul), and the stupid faces of anyone who still believes in getting, or giving, a free lunch to, or from, anyone, especially the government, which is so corrupt that it once gave smallpox-infected blankets to the American Indians, which is only marginally worse than destroying the currency of the country and makes you reflexively scream in horror every time you see the money supply go up.

Well, it does me, anyway.

Instead, she goes on that the result was that since then, "the purchasing power of a dollar has plummeted over 95%", which means that "We now pay twenty times more than J.P. Morgan did for any item." Yikes!

Suddenly, my ears pricked up as she said, "Few have written on the mechanics of getting back to sound money", which I immediately noticed makes me a genius, meaning that people should worship my gigantic brain, my wife and kids should stop calling me "idiot" and saying how much they hate me and maybe I should get a Nobel Prize.

The reason I am suddenly so enamored of my intellect is that achieving a "sound money" is the easiest thing in the world! Just stop creating more of it! That's all you need! It's simple! It is my Profound Mogambo Genius (PMG) that has solved the puzzle!

Okay, I am embarrassed that I got carried away there, and I admit that I am not very smart, and that is why I stole the whole idea from the fact that this is all the gold standard did; it prevented increases in the money supply, and the only thing that Congress had to worry about was doing smart things so that gold came into the country (increasing our money supply) and not doing something so stupid that it went someplace else better (decreasing our money supply).

But those days are all over now, and the only people who are buying gold, along with silver and oil, are the people who know what happens to an unsound, fiat currency (like the dollar) in the hands of a government composed of a bunch of socialist, commie-think yahoos (like the US Congress) that willingly deficit-spends insane amounts of money thanks to a central bank (like the Federal Reserve) creating it and a population sitting around saying, "Duh! Okay with us!" Hahaha!

We're freaking doomed!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• Gold in the Art of Bread Consumption
• Federal Reserve Has Destroyed the Economy
• A Government of Spendaholics
• Oil Prices Has The Mogambo Guru Sticking His Thumb in His Eye
• Greenspan and His Demented Federal Reserve Chairmanship

How did Australia get caught up losing money in commercial U.S. real estate? In yesterday's Age, Bwembya Chikolwa, a lecturer in the School of Urban Development at Queensland University of Technology, says Aussie super funds had money to burn and listed property trusts, with their large portfolios of U.S. assets, were liquid enough to do the trick.

"Unfortunately they were caught up in circumstances to do with the financial crisis," she says. "Moving into the US wasn't a problem because it had more or less the same settings...It was driven by large investment inflows into the super funds...The super funds needed new investment avenues and the trusts were a good avenue. So they invested through the listed property trusts. They had the funds and had no choice but to move offshore and the US market because of its size."

No choice? A portfolio manager always has a choice. It's the retail investor who is forced into compulsory super that has less choice. But this does highlight the obvious fact that fund managers are not paid to put clients into cash. Self managed super investors can do this easily enough, and many did (whether by design or indifference), thus avoiding the share market wipeout. But big fund managers have to buy big stocks. They are too big to buy small stocks, by the way, which creates a niche for Kris Sayce at the Australian Small Cap Investigator.

But now we have yet another seemingly external threat to your cozy domestic retirement: U.S. commercial real estate. Yesterday's Wall Street Journal reports that the $700 billion U.S. commercial mortgage backed securities market saw a delinquency rate of 3.14% in July. That was up six times from the year before.

The Journal reckons that over $153 billion in loans need to be refinanced by 2012. Of that amount, at least $100 billion could be in trouble. Why? The underwriting on the original commercial real estate loans was dodgy (as it always is in a credit bubble). But more importantly, with property values on commercial real estate down by 50% in some areas, refinancing at the same loan to value ratio as before just isn't going to happen.

Cash flows are fine for debt service and principal repayment now, according to the Journal story. It's the write down in property values that will scupper the refinancing. What's more, because the loans were securitised, it's often hard to figure out who you should be renegotiating with. This is reminiscent of the residential mortgage backed securities market where Deutsche Bank couldn't proved it owned the properties it wanted to foreclose on.

Mortgage servicers, banks, and investors would all prefer the problem to go away so no one has to take a write down on their asset values or a loss on their securities. But Aussie firms already know better. The only question now is if a pear-shaped U.S. commercial real estate market will do as much (or more) damage to the global financial system as the residential housing market. Stay tuned....

Dan Denning
for The Daily Reckoning Australia

• Property Sector Has Seen the Value of its Assets Wiped Out
• Commercial Mortgage Backed Securities Are Back
• A Look at Debt and Super
• Paying Attention to the Risk from Deleveraging in Commercial Real Estate
• Your Average Australian Super Fund

Meanwhile, oil stocks in New York surged along with crude oil. The Department of Energy in the U.S. said crude stock piles were down. This, among other things, sent front-month crude futures up 4.7% to $72.72.

By "other things" we mean that the market realises not enough money has been invested in new energy projects to meet new demand. The International Energy Agency reckons the credit crunch led to the cancelling of over $170 billion worth of oil and energy projects worldwide. This explains the feeding frenzy around LNG projects in Australia.

And speaking of that, Pluto is catching up with the Gorgon. The energy story is dominating the resource sector at the moment. Yesterday it was Woodside Petroleum saying it would triple production from its Pluto LNG plant by 2014. Pluto is scheduled to enter into production ahead of the Gorgon project, which was all over the papers yesterday.

Woodside's shares reacted to the favourable production schedule yesterday. They were nearly up 3.5% while the rest of the market stagnated. And there was movement in the eastern LNG projects too. You may have seen earlier this week that Origin Energy selected a site for its LNG terminal in its LNG joint venture with Conoco Phillips.

The final investment decision won't be made until next year. And if it's a go, the project won't begin production until 2014. Kris Sayce reckons his small cap tip is a better bet for making punters money now. It will enter production much sooner. The only big difference is that the share Kris has recommended in his Small Cap Letter is involved in a smaller project.

"The project will deliver 1.5 million tonnes of LNG per year," says Kris. "But it's going to be the first project that actually produces LNG in the region. It's located closer to the coast. And it's scalable. The LNG terminal it's building can take production from other players in the region. And it will already be up and running when other trains get into production."

Does the surge of Asian and especially Chinese interest mean a new source of strength for the Aussie dollar? Robert Gottliebsen thinks so. He made an interesting point yesterday over at Business Spectator. He wrote that, "The Chinese now know that they can invest in Australia and not face a serious currency risk. We are going to see them buy property in the eastern states and they will support our debt markets on a much larger scale."

He added that, "There is enormous concern in China about the US currency and the fact that there could be huge losses ahead for China if the American dollar falls...HSBC research shows that China does not face that risk in Australia. Global investors who want to invest in China can do so via Australia with far less risk. Accordingly, our share market is set to follow China."

He may be right. It's certainly true that trading U.S. dollars for Australian real assets (be it LNG, coal, iron ore, or real estate on the east coast) is probably a good trade for China. It has several trillion in foreign currency reserves, the bulk of which are denominated in U.S. dollars. There are going to be heaps more dollars printed in the coming years, given the reluctance of the U.S. government to either increase taxes or reduce spending in order to tame its deficits. Inflation is the way out.

Here in Australia, that apparently means more debt is acceptable. Treasury secretary Ken Henry says that because of Australia's privileged position relative to the China boom, the country can run higher current account deficits without having to worry about a run on the dollar. Henry has said Australia "might attract an even greater share of global capital flows, and quite possibly even larger capital flows in aggregate."

Because the Aussie dollar is not the U.S. dollar, let us add more debt!

There are many factors that might make Australia a desirable place for foreign capital. It has a stable political system, a fairly sensible regulatory framework, a commodity currency, and a whole lot of beach front property. But we'd be wary of using that as an excuse to run higher current account deficits, importing more than you export. It's a bad habit to get into. Just ask Warren Buffett.

Buffett wrote an op-ed in the New York Times pointing out that America's Federal deficit of $1.8 trillion is not just 13% of GDP. It's "unchartered territory." "Because of this gigantic deficit," he wrote, "our country's 'net debt' (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent."

Australia's net debt, by the way, is around 56% of Aussie GDP. This growth of that figure indicates you owe more and more to foreigners and that your own domestic growth is financed by foreign borrowing. It also means the income from your national assets may increasingly go to foreign bond holders. A high net-debt to GDP position is not a good one to be in.

"Admittedly," Buffett adds, "other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to GDP at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out."

"The Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington's printing presses will need to work overtime. Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can't come close to bridging that sort of gap."

So Buffett has admitted that you can't grow an economy out of that much debt. That is bad news for America and the U.S. dollar. But what does it mean for Australia? Well, that's a good question.

It might mean that U.S. creditors (like China and Japan) would be happy to fund Australia's modest debt levels, given the higher yield on a stronger currency. That might lessen Australia's vulnerability as a capital importer. It might even mean that interest rates have to go up less fast than Glenn Stevens currently thinks.

But does it also mean Australia is slowly becoming a vassal state to China? The economy is dependent on Chinese trade. The funding of government deficits and a larger net debt position will be dependent on Chinese capital. If the government has little leverage in the Stern Hu case now, how much more will it have in ten years if these trends continue? And is there anything that can be done about it? More on this tomorrow.

Dan Denning
for The Daily Reckoning Australia

• BHP Billiton: The Oil Company That is Not an Oil Company
• Foreign Investment in Australia, How Much is Too Much?
• Wage Pressure in China to Drive Up Cost of Goods in Australia
• Energy Debate in Australia Needs to Get Serious
• Big-picture Case for Energy Stocks is Pretty Bullish

And none too soon! The big box retailers are soon to be dinosaurs. They are living monuments to cheap energy and globalisation. Only cheap energy and cheap global labour make it possible for goods to be shipped this far and sold this cheaply.

We thought this era of retail decadence was well and truly over with the Global Financial Crisis. But the Costco opening is a nice, nostalgic coda to the whole era of misallocated real resources and capital. While the suburban-retail-housing economy of America crumbles, Australia has built a small shrine to that way of life down in the Docklands.

Mind you, we don't have any problem with lower prices. There's a bit of snobbery about American attitudes toward Wal-Mart and other giant retailers like Costco. After all, isn't it a good thing when a large part of the population can reduce the amount of money it spends on basic food and necessities? These stores really do lower prices on the things people buy every day. To that extent, they should be celebrated as an achievement of capitalism.

Of course there are consequences to organising your economic life around discount retailing. Mom and pop shops-mostly neighbourhood places with friendly faces (if higher prices)-can't compete with goods and textiles imported by the container ship full from Asia. The folksy local retailer is crushed under the heel of the big box with the big global footprint.

This necessarily changes the job market too. Some small businesses-usually the largest employer in an economy-go to the wall if the big box retailers start popping up everywhere. More and more jobs in the economy shift to lower-wage retail sales. Fewer people are employed making things and more are employed selling them (often on credit).

Gosh. It feels like we're writing a history of what happened to the American economy over the last twenty years. Cheap oil, credit, the container ship, sophisticated logistics systems...all of these combined to deliver a one-off massive decrease in the cost of living for Western workers. Whether or not the lower cost of living resulted in a higher quality of life is a different question. And the trade off was the slow erosion of real wages from globalised labour.

Anyway, the appearance of the Costco in Australia is like a time machine from the retail past arriving. A massive Tardis from Dr. Who, filled with the cheapest underwear on offer and mountains of washing detergent, deeply discounted. We will probably head on down this weekend to see if they have Coca Cola by the barrel.

Nothing in the market can compete with our excitement about the appearance of Costco. But yesterday we speculated that energy would be the best inflation beater of the next ten years. And out in Perth, The West is reporting that, "Australia is on the verge of another WA-led resources boom that promises to dwarf the last surge, lock in thousands more jobs and be worth billions of dollars to WA businesses."

The paper refers to the Gorgon LNG project. Gorgon is not, at least in this case, an ugly, snarling, snake headed female figure from Greek mythology. Nope. In this case, Gorgon is a $50 billion Liquefied Natural Gas (LNG) project that aims to produce 40 trillion cubic feet of LNG off the coast of Barrow Island in Western Australia. The project exists because energy itself is no longer cheap, but still in demand.

The main partners in the development of Gorgon are Chevron, Exxon Mobil, and Royal Dutch Shell. In fact, just last week Exxon signed a $25 billion deal with India's Petronet to sell 1.5 million tonnes of Gorgon LNG to India each year for the next twenty years. That's a big off-take agreement. There will be more, probably from firms in India, China, Japan, and Korea. Asian power utilities prefer cleaner-burning LNG in their electricity producing plants.

A final investment decision by the partners is expected early next month. But that's a near certainty now. With the WA and Federal governments granting the environmental permits necessary, there was only one big hurdle left, and that was cleared yesterday. Once it's played out, the Gorgon field has been identified as a place to store captures carbon dioxide.

Yesterday, the Federal government indemnified the partners once the site is closed. That essentially means that the gas partners are responsible for producing LNG. The Federal government, meanwhile, assumes any risk if there is a problem with using the site as a place to store captured carbon dioxide.

Gorgon is Australia's biggest energy project. But it is not one punters will probably make much money on. The big companies involved in the project have massive global exploration and production portfolios. As big as Gorgon is-and as important as the off-take agreements are to firms in Asia-Aussie punters ought to look at the three or four other prospective LNG producing regions in Australia.

This is what your editor and Kris Sayce have been up to for the better part of the last six months. Kris has cherry-picked the best plays from Queensland's unconventional LNG plays near Gladstone in the Australian Small Cap Investigator. Over at Diggers and Drillers, your editor has looked at other unconventional gas plays, mostly natural gas trapped in sandstone formations in certain basins around Australia (so-called 'tight gas.')

Who knows which projects will end up prospering? No one yet! Already, some of the stocks are prospering on the speculation. Investors know that energy is Australia's most valuable long-term commodity export. The smaller players in the market are already pricing that development in.

We still have a few energy-related projects to add to our resource shopping list. We don't think we'll find them at Costco. But maybe we will finally find some Captain Crunch!

Dan Denning
for The Daily Reckoning Australia

• Buying Oil on Sale as U.S. Dollar Gets Weaker
• Inflationists Reappointed at the Fed
• Gorgon LNG Deal with China a Really Big Deal
• CNOOC Signs Agreement With Altona (LON: ANR) for Coal to Liquids Project
• A ‘Draw’ in the ’Flationary War

"You can forget about getting anything done in the month of August," said colleague Simone Wapler. "The French are busy with serious things...real things...like painting shutters and picking green beans...fixing curtains and making strawberry jam. They don't want to hear about economics or markets..."

France begins its summer vacation today. We've come to join them...

But we will keep an eye on the money anyways...because it's just getting interesting...

Two interesting things are happening. First, the feds are facing a showdown with the vigilantes...you know, the people with money - $2 trillion worth of reserves, $1.5 trillion of it in U.S. Treasury paper. They've got to convince them that they'll protect their investment. If they fail, the vigilantes sell their bonds...cause the dollar to collapse...and force up U.S. interest rates - which will come down like Round-Up on those green shoots of recovery.

Meanwhile, stocks are not only anticipating a recovery, they're counting on it. And for that, they depend on stimulus from the feds. But what Bernanke gives in stimulus, the vigilantes are likely to take away...

More on that in a minute...

The other big thing that is going on is the rally in the worlds' stock markets. On Wall Street, for example, the Dow rose 96 points yesterday. How far will this rally go? Should you try to take advantage of it?

As a rough rule of thumb, a bounce can be expected to recover half of the losses from the crash. The Dow went down 7600 points below its pre- crash high. So, we can expect a rebound of about 3800 points - which would put the index back around 10,300. By that measure, this rally could still have a lot of life in it - enough to convince practically everyone that the depression will soon be over. Don't believe it. This depression is going to last at least a few years...and the bear market isn't over. The Dow will eventually close below 5,000. At least...that's our story and we're sticking with it.

But let's go back to poor Ben Bernanke. And poor Tim Geithner. The poor fellows don't seem to know what they are doing. But why should they? Ben Bernanke spent his career as a professor of economics. Modern economics is fundamentally an intelligence-destroying trade. The longer you spend in economics, the less you know about how the economic world functions. Many years ago, the profession got the wrong idea of what it was up to. Ever since, it's been barking up the wrong tree. (More below...)

As for Geithner, he is a smart young man...destined for hackdom almost from the day he was born. Ivy league university...consulting firms...government - a protégée of Robert "Nobody Saw the Crisis Coming" Rubin - you can't blame Geithner either; he hasn't had time to think about how an economy really works.

But at least their mission is clear: to convince the world of two things at the same time...both impossible and mutually exclusive! The Chinese vigilantes must believe that the feds won't undermine the dollar...and the rest of the world must believe that they will! Inflation is necessary for recovery and growth in the United States...or so everyone believes.

It was French economist Jacques Rueff who revealed the scam more than half a century ago. The whole idea of Keynesian stimulus, he explained, was to cause inflation...which would reduce the real price of labor. In a modern democracy, politics prevents wages from falling. But in a correction, if wages don't fall people don't get jobs. Keynes' didn't mention it, but the only reason his stimulus works is because it pulls the wool over the eyes of the working classes - reducing their wages by inflation so employers can afford to hire them again. Ergo, no inflation...no recovery in the job market. No recovery in the job market...no recovery in the economy.

But inflation will cost the Chinese plenty. And they've let it be known they won't sit still for it. Keep reading...

"China seeks assurances that US will cut its deficit," says a New York Times report:

"China sought and received assurances from the Obama administration that the United States would reduce its budget deficit once an economic recovery was under way, a senior Chinese official said Tuesday at the end of two days of high-level talks between the countries.

"Attention should be given to the fiscal deficit," said Xie Xuren, the Chinese finance minister. He said Treasury Secretary Timothy F. Geithner had assured the Chinese that once the economy rebounded, the deficit would gradually come down from its current record levels.

"Mr. Geithner confirmed that, saying, 'As we put in place conditions for a durable recovery led by private demand, we will bring our fiscal position down to a more sustainable level over time.'"

Did you notice, dear reader? Geithner promised a "durable recovery led by private demand." In other words, it won't be government spending that pulls the United States out of its slump, he told the Chinese.

He must have had his fingers crossed behind his back. At this stage, what other kind of demand is there? Are factories being built? Are they hiring? Are consumers borrowing and spending more? As we pointed out yesterday, private demand has collapsed ...and it's likely to collapse even more.

But let's stick with our vigilantes for a while. Inflation would cause them to lose money. More importantly, it would cause them to lose face. American officials have told them not to worry; the Chinese seem satisfied. But woe to the debtor who lies to his creditor; he gets cut off.

Meanwhile, a report from the IMF names Britain and the United States as the world's two biggest spendthrifts...and sees no end coming soon.

A global recovery is "not yet under way" and likely to occur at different times around the world, so pulling back public spending and investment may be "premature," the IMF staff said.

Additional discretionary spending may be needed in 2010, the report said.

The staff report also said inflation expectations are picking up, posing a risk to a rebound in economic growth.

"Preserving investor confidence in government solvency is key to avoiding an increase in interest rates, thereby not only preventing snowballing debt dynamics, but also ensuring that the fiscal stimulus is effective," the report said.

The IMF noticed the fix U.S. officials are in.

"On the one hand, a too hasty withdrawal of fiscal stimulus would risk nipping a recovery in the bud," the report said. "On the other hand, with a delayed withdrawal investor concerns about sustainability may increase, leading to higher interest rates on government paper, undermining the recovery and increasing risks of a snowballing of debt."

The IMF staff urged countries to develop medium-term strategies to rein in rising debt levels. Some countries already have begun to do so, the report said.

The economists at the IMF see this as a problem of "balancing risks." Here at The Daily Reckoning, we see it differently. To us, it is lies colliding with each other. Stimulus will not produce genuine prosperity. You can't cure a credit-caused crisis by offering more credit; it just won't work. But rather than let the system correct itself, the feds are determined to 'do something!' What can they do? They can only destroy the dollar - or try to - thereby destroying the value of China's $1.5 trillion treasure.

Now, more on why private demand is going to weaken, not increase.

As the boom of the post-war period continued, consumer spending played a larger and larger role in the economy. It averaged 64% of the GDP during most of the period, but increased to 70% in 2007. Likewise, debt service as a percentage of disposable personal income rose too - from less than 5% in the '50s and '60s to over 14% now.

If, as we suspect, the trend towards more and more consumer debt has finally peaked out; consumption should have peaked out too. We should now see the percentage of the economy devoted to consumption go down...year after year...until it reaches the 'normal' level. Private debt too should go down, until it is at a more 'normal' level.

We calculated that during the last 7 years of the Bubble Epoque consumers added $1.4 trillion in debt per year. That was the spending that made the old mare go. But now what? They are now adding no debt - zero. In fact, they are paying off debt. This alone removed $1.4 trillion in private demand from the economy.

The savings rate is up dramatically too - from zero to 7%. This is another way of measuring the same phenomenon: the decline in consumer spending.

The only thing that would cause consumer spending to go would be a substantial increase in real wages. This would allow Americans to buy more - while simultaneously paying down debt. But with 16% unemployment (Rosenberg's estimate) it will be a long time before real wages increase at all...let alone substantially.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Investors Are Betting On Recovery
• Roubini Says United States Will Climb Out of Recession Towards End of Year
• Why Weren’t Economists On Top of This Thing?
• Geithner’s Trip to China Was, At Best, a Draw
• The More Money in a Financial System the Less Each Unit is Worth

"It is about five years since I first read the DR and agreed with your recommended 'trade of the decade.' At that time it was clear to anyone who saw the busts of 1974, 1991 and 2001 that the next one was imminent, even though politicians, ratings agencies, financial services and real estate company directors and mainstream financial journalists were all 'asleep at the wheel.'

"But were they? Maybe they saw it too but it did not suit them to take measures to prepare for the bust. After all, those in positions of power and influence are using other peoples' money to feed their ambitions and egos, and would probably have made very different calls had their own money been at risk on such a huge scale.

"Fortunately, with my conviction stiffened by your comments in the DR, I sold down all the holdings in my family property investment company in the UK between 2004 and 2007, repaying £18m of bank debt in the process. 50% of the proceeds went into gold and silver. We have not made any money in the last year but this strategy has resulted in no loss in the credit crunch...yet!

"So well done, Bill, on giving the baby boomer generation a lifeline in the form of sound common sense comment - and as you remind us, it is free!

"Keep up the good work. I still await Gold:Dow - 1:1 although I may not live that long!"

Ah, there's the rub...we may not live long enough...

Surely the Dow will trade at a p/e below 8... And gold will trade at one times the Dow.

But when?

As we told the group in Vancouver, it will happen...but there could be a whole lot of depression before it happens. Depression could drive down gold prices...and discourage gold bulls. It could ruin stock portfolios...bankrupt pension and insurance funds...and put millions more people out of work.

We don't doubt that the feds have the power to destroy the currency and create inflation. We doubt that they can do it in a controlled, gentle way. As the depression worsens and lingers...they'll become more and more desperate to raise inflation rates. They buy more bonds. They increase the money supply. They'll become more and more reckless as prices fail to reaction.

Then...inflation rates won't go up gradually...they'll go up all of a sudden...surprising almost everyone. Holders of dollar bonds - notably the Chinese and Japanese - will panic and sell. All Hell will break loose.

Will it happen in our lifetimes? Depends on how long we live...

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Paying More Than 3 Times as Much for Gold
• Deleveraging Will Give Us a Bout of ’30s-Style Deflation
• Does This Mean You Should Sell Your Gold?
• Life After the Credit Depression
• One in Six Homeowners is Underwater

It is my contention that we will get neither hyperinflation nor deflation.

What is more likely is that over the coming months, we will get another deflationary scare. Any sell-off in the markets later this year will be met by an even larger stimulus from the policymakers and this will ultimately result in high inflation.

So, I maintain my view that due to the unprecedented policy responses around the globe, the world's economy will face high inflation over the medium to long-term. And the general price level will double over the
coming decade.

In the near-term however, we will probably get another period when the market will (once again) become concerned about the prospects of a lengthy economic contraction. It is conceivable that the 'green shoots' hype currently doing the rounds will soon be replaced by more economic worries as a second wave of foreclosures hits America later this year. So, it is possible that before year-end, we will witness large corrections in stocks and commodities. Conversely, we are likely to see big rallies in U.S.
government bonds, U.S. Dollar and Japanese Yen.

This near-term vulnerability in the markets is the reason why I have recently liquidated my 'long' positions in resources and emerging markets and gained a heavy exposure to long dated U.S. Treasuries. In my view, a
defensive investment stance is prudent at this juncture, as it will protect our capital and allow profit from the expected contraction. Once the pullback in the markets is complete, I will liquidate my positions in U.S. Treasuries and re-invest our capital in our preferred holdings in energy, materials, mining
and emerging Asia.

Look. In the business of investing, the tape never lies and it is worth remembering that Wall Street is littered with the graves of those who got married to one particular outcome and then held on to their ill-conceived
notions. At this point, when private-sector debt contraction in America is locking horns with central bank inflation, I prefer to have an open mind. Therefore, I am maintaining a defensive near-term investment position. If the market corrects over the following weeks, I will be in a position to profit from such a decline. On the other hand, if the major indices simply consolidate here and break above the recovery highs recorded last month, then I will have no hesitation in changing my defensive investment position. Put simply, I am currently watching and waiting patiently for the market to reveal its hand.

Coming back to the subject of this essay, the reason that I don't foresee immediate hyperinflation is because the velocity of money is currently weak. In other words, at least for the moment, the private sector in America isn't participating in Mr. Bernanke's inflation agenda. Despite the fact that Mr. Bernanke has injected a massive amount of reserves in the banking sector, this money is currently sitting as excess reserves within the American banking system. The fact that this money isn't being lent out rules out immediate hyperinflation. However, once the American economy stabilizes and the velocity of money picks up, these excess reserves will trigger a massive inflationary wave.

As far as deflation is concerned, I am of the view that the policy responses and our fiat-money system will ensure that the purchasing power of cash will continue to diminish over the medium to long-term. In fact, I am willing to bet that cash will probably be the worst performing 'asset' over the coming decade. Remember, in today's monetary system, central banks and governments the world over are free to create money out of thin air and this will prevent outright deflation in the global economy.

It is worth noting that in the past six months alone, China's commercial bank credit has expanded by a whopping US$1 trillion! Figure 1 highlights the surge in Chinese bank lending. Furthermore, credit is also expanding frantically in other Asian nations. So, contrary to the West, monetary policy is still alive and well in the developing nations and this factor also rules out outright deflation in the global economy.

In my opinion, rather than hyperinflation or outright deflation, we will witness elevated inflation after the American economy has stabilized. In the interim however, investors should be prepared for another deflationary scare and the associated market panic.

Regards,

Puru Saxena

for The Daily Reckoning Australia

• Inflation or Deflation?
• Hyperinflation and the Dollar’s Monetary Destiny
• Why Inflation Or Hyperinflation Lies in Wait for the U.S.
• Inflation is Our Future
• Hyper-Deflation on the Streets of Paris

Energy is a great long-term investment theme. As we've mentioned before, the collapse in capital spending in 2008 almost guaranteed that any resumption in demand growth would trigger higher prices because of much lower supply growth. Everyone's been focused on inventories and the global recession. But it's supply that you should keep your eye on.

Of course Goldman is just talking its own book. Everyone is talking his own book, come to think of it. But in this case, we like the book. And more importantly, we think a carefully selected portfolio of energy shares (conventional, unconventional, and alternative) is big part of making money as an investor over the next five years.

Switching gears, did you see what RBA governor Glenn Stevens said yesterday? He said the RBA would be willing to cut rates again if it needed to. But he also said, "It would be counterproductive, though, if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates."

Wow. What's gotten into these central bankers lately? First Ben Bernanke puts on his serious face and tells the U.S. Congress that large deficits threaten financial stability. And now we have Mr. Stevens pointing out the dirty little secret of lower rates. They encourage debt bombs that become debt bombs.

Shhh though. Don't tell anyone else. It would be bad for confidence.

Do you think maybe Dr. Bernanke is just trying to talk his book too? After all, the U.S. Treasury has heaps of debt to sell this year (gross issuance over $3.25 trillion according to Goldman). If Dr. Bernanke makes adult sounds come out of his mouth, it might give people the impression the U.S. is returning to sobriety and fiscal sensibility.

And on due, ten-year bond yields did in fact fall in Thursday trading in New York. Ten-year yields on U.S. notes now stand at 3.54%. Remember that after the Fed said it would be buying U.S. bonds, yields plunged to 2.04% in November of last year. But by May 28th-as the true scope of America's debt bonanza became apparent to global investors-yields soared to 3.75%.

We still think bond yields are the prime mover in this market, but not for the reason that you'll read in the paper. Investors aren't selling bonds because the economic recovery is sound and stocks hold better value. You're seeing a bear market in sovereign bonds because many governments are running into a fiscal and demographic brick wall.

Bond yields also hold the key to explaining how a higher Aussie gold price is possible given the Aussie dollar's recent strength against the greenback. With the Aussie chugging along against the USD, it's been an uphill climb for gold prices in Australian terms. But just you wait.

The yield on Aussie ten-year notes was 4.88% in mid-May. It's now 5.67%. That's a 16% rise in three weeks. Granted, it's not the huge spike you've seen in U.S. yields. But it does tell you something.

It tells you that the Australian Office of Financial Management has its work cut out for it in selling the $1.4 billion in debt a day to finance the country's growing federal deficit. You borrows the money and you pays the higher interest rates. Or, your central bank-like the Fed-does its part if necessary to buy your debt.

Inflation on the way with real interest rates negative

Source: Reserve Bank of Australia

That sort of debt monetisation isn't on the cards yet in Australia. For now, there should be plenty of domestic and foreign investors willing to add a little high-yield government debt to their portfolios. But given the chart above that shows-by the RBA's own admission-that real interest rates are already negative, there are plenty of monetary forces already in the mix in Australia that will lead to expansion of the money supply.

That sort of monetary expansion, along with deficit spending and higher yields, is just the sort of thing that's going to power Aussie gold and precious metals prices higher. If it doesn't, we'll eat every single hat here at the Old Hat Factory.

Dan Denning
for The Daily Reckoning Australia

• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis
• What Inflation Means to Central Bankers, Investors and the Consumer
• Government Debt Bubble is What Directly Precedes Inflation
• How U.S. Mortgage Rates Affect Aussie Stocks
• Now in Post-bubble Era as Financial Industry Bombs Out

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

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

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

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

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

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

Big mistake.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

2. It prevents you from handling your money recklessly.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Now it's your turn.

Regards,

Alexander Green
for The Daily Reckoning Australia

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