On the latter, here's what Addison had to say:

"'Deflation now, inflation later' is a mantra we've adopted at The Daily Reckoning. The Federal Reserve, through it's program of quantitative easing, is busting the seams of its own balance sheet in order to fight a deflationary trend in the West. At some point, the tide will shift. Mr. Bernanke assures the world he's watching inflationary indicators like a hawk. We have our doubts whether those indicators will do him any good. As Paul Volcker, the great inflation slayer of the early 1980s, said when we interviewed him for I.O.U.S.A. 'Once inflation gets started, it's very hard to stop. And there's a strong flavor of that at the moment.'

To read Addison's full interview, see here.

"Global trade rose at its fastest rate in more than five years in July," The Financial Times reports, "suggesting the economic recovery is feeding through into commerce."

"I've been worried about the effects of protectionism in shutting off different markets and making a weak economy even worse off," says colleague Chris Mayer. "Commodity markets especially need open markets to function well. The EU, for example, just put a 40% tariff on Chinese made steel pipe. That's not good for steel pipe demand and hence, the steel makers and the commodities that go into steel. If we see widespread adoption of such measures, we'd have to re-think some things.

"But so far, it looks like we've got a recovery of some kind in global trade. When I look at the global economy, many of the bright spots stem from surging trade along old trade routes (such as China and Arab world)."

Racehorse prices are in freefall, says a report out yesterday. But collectible cars are still doing well.

Yesterday, we saw someone drive by in a huge, gaudy pink Cadillac from the 1960s. It had magnificent fins and enough chrome to stagger a blind man. In it were a middle-aged man and woman, looking very comfortable and proud. They were traveling in style...in a rolling sculpture.

Old cars are not only holding their values, they're still going up. But not all old cars. Detroit's muscle cars have been falling in price for the last three years. Not very green?

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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"China also bought 590,000 tonnes of aluminium, 159,000 tonnes of zinc, 30 tonnes of indium and 5,000 tonnes of titanium, said Yu, who works in the National Development and Reform Commission's industry department." Now that metals prices have rebounded, though, will the stockpiling continue, even at high prices? Or was it a case of bargain shopping at everyday low prices?

There are several components of demand. There's real economic demand (you need the stuff to make other stuff). There is investment demand (you're buying it in order to make a profit from what you think the price trend is. There is also pure speculation, and it's possible that some middle-men were flat-out speculating by buying alongside China's State Reserve Bureau (sort of like the banks and brokers in the U.S. buying Treasuries ahead of the Fed late last year to improve Q4 earnings).

But if you're trying to figure out the ultimate direction of certain base metals prices (or commodity prices in general) you have to also consider the currency in which they're priced. Or, as my colleague Dan Amoss writes, "You also want to consider what Ben Bernanke and Tim Geithner will do to debase the dollar in the coming years. If you're a foreign creditor facing with this constant portfolio decision, which has higher marginal utility? Is it 1.) US$2.32 or, 2.) one pound of copper?"

Dan is referring to a pretty handy economic concept. Marginal utility is the economist's attempt to quantify how much satisfaction or benefit you get out of each additional good or service you buy. You have probably heard the term "diminishing marginal utility" more often.

An easy way to understand this is that while one cheeseburger may satisfy your appetite (and your craving for animal fat), four cheeseburgers gobbled down in a row are neither useful nor terribly good for you. They might even be bad (although as an American, we are reluctant to concede this point).

In Dan's scenario, U.S. dollar holders will ask themselves if each additional dollar owned is more useful. Given the fact that the U.S. monetary authorities are making so many dollars, it's pretty clear that each additional dollar added to supply makes each existing dollar less useful. It is not very satisfying to see a methodical reduction in the purchasing power of your savings.

If Dan is right, then stockpiling real assets (even during a relatively weak economy) makes more sense that stockpiling U.S. liabilities. Or, as Dan says, "The Chinese will probably go with #2, especially because copper (and oil, and iron ore) can be stored and used in infrastructure projects to keep the population somewhat placated with infrastructure jobs," says Dan.

He adds that you should look for the Chinese to stockpile resources on the dips in commodity prices, while selling/divesting of U.S. Treasuries into the rallies that come with 'safe-haven' buying. That sounds right to us. But the only catch to the plan is if Treasuries fail to rally on safe haven buying.

On that score, the Treasury market seemed to survive last week's big auction without a huge spike in yields. If the economic news remains neither bullish nor exceptionally bearish, then we reckon Treasuries could rally (prices up, yields down), providing a discrete exit opportunity for certain large investors.

Incidentally, we still haven't seen much in the Australian press about the long-term consequences of government deficits. That's probably because most people are accepting the government's case that Australia's borrowing (and its deficits) will be temporary. We're not as sure. And besides, there are some serious questions about how structural deficits affect a country's currency, its credit markets, and its interest rates.

Those are just some of the questions we hope to take up at our upcoming debt symposium/summit, which will precede the first Australian screening of I.O.U.S.A. We've even picked a date, booked a venue, and secured a cracking panel of experts to train their eye on Australia's very own addiction to debt. Stay tuned for your official invitation!

Meanwhile, did you see that China has astonishingly and rather conveniently discovered some 3 billion metric tonnes of hematite and magnetite iron ore? It's apparently true, and probably comes in pretty handy during the current stagnated annual price contract discussions with Aussie iron ore producers BHP Billiton and Rio Tinto.

As you know, China is the world's largest steel maker and thus the largest importer of iron ore. Chinese geologists claim they have found Asia's largest iron ore deposit ever in Benxi city, which is in the northwest province of Liaoning. The good news is that the deposit is said to be about 2.5 miles long and 1.8 miles wide and could, officials say, have a mine life of 50 years-if a mine is built.

The bad news is that the resource (not a reserve because it's not know if it can be produced economically) is buried around a mile underground. That's a long way down, or a long way to lift iron up, if you prefer, and if you're strong (which China is).

Contrast that with the Pilbara, where the stuff seems to lying around waiting to be found in the hundreds of millions of tonnes by any Tom, Dick, or Kerry. That's right. Iron Ore Holdings, owned by Kerry Stokes, told the ASX yesterday it was increasing by 50% its estimate of its mineral resource at Iron Valley in Western Australia.

This deposit is only 97 metres below ground. It's surrounded by big projects by BHP, Rio, and Fortescue. And the company says it reckons its sitting on a 132 million tonne resource-which is up from the 88 million tonnes it believed it had just three months ago.

Proving up a resource into a reserve-and seeing your share price benefit because of it-is the name of the game for the iron ore juniors. Despite the big Chinese find, we reckon the Iron Valley story is where the Big Picture meets the Little Juniors (or where the rubber meets the road, if you prefer).

At the right prices, stockpiling commodities makes sense to people who will need them later anyway and already have too many U.S. dollars. And if prices aren't right...if..in fact...commodity prices decline (either because of slow economic growth or a halt in stockpiling) then commodity stocks probably fall a bit too...which makes those very stocks-especially the smaller ones that need capital and JV partners-the next logical candidates for acquisition or accumulation.

Dan Denning
for The Daily Reckoning Australia

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First though, if you think Australia's entry into-deficit land doesn't eventually threaten its credit rating, let us take you back to the quiet London conference room of a hedge fund, circa 2003. Your editor was in the small crowd, along his friend and author Addison Wiggin, listening to an informative speech by a U.S.-based analyst on the "duration gap" between Fannie Mae's short-term liabilities and its long-term assets.

It may not sound that exciting, but what transpired over the next thirty minutes was a real eye opener. The analyst pointed out that if you borrow short-term and lend long-term, you expose yourself to changes in interest rates. You may have to refinance your debt at much higher interest rates, while the value of your long-term assets falls.

This was a problem, for the GSEs, the analyst insisted, because their assets-residential U.S. mortgages or mortgage backed securities-paid off over their long-term while their liabilities-the bonds they issued to finance their purchases of mortgages in the secondary market-were short term.

Even though the GSEs enjoyed lower borrowing costs than other corporate borrowers because of their implied U.S. government guarantee, he said, they would face higher borrowing costs if interest rates spiked. If that were to happen, the GSEs would likely be unable to grow their balance sheets or earnings. When your business is essentially borrowing money to buy mortgages, higher interest rates not only make borrowing more expensive, they also (as we've seen lately) affect the value of your assets. Higher interest rates meant death for the GSE growth model, he predicted.

For the GSEs, the rest has been history. While the financial media were busy glorifying the results of the bogus stress tests last week, Fannie Mae quietly reported a $23.2 billion first quarter loss (this followed a $25 billion fourth quarter loss). It also asked the government for another $19 billion in 'capital'. The company said, "persistent deterioration in housing, mortgage, financial and credit markets continued to adversely affect our financial results."

To his credit, the analyst in our London conference room saw all of this coming. After his presentation we stuffed a few canapés in mouth and asked him this question, "If what you said about the GSEs is correct, and the U.S. government is forced to make its implied guarantee of GSE debt explicit, wouldn't the increase in Federal liabilities threaten the U.S. credit rating? After all, you're talking several trillion dollars [at the time] in GSE debt. That would be a big increase in government liabilities."

"Oh. Well. Gee. I don't know about that. I mean, if that happened it would mean....well...it would mean..."

"The end of the dollar standard and the end of the dollar as the world's reserve currency?" we helpfully suggested.

"Well, yes," he chuckled. He seemed to regain his composure. "That's highly unlikely. I mean, that's a major development. It would be a big deal. That probably wouldn't happen. It can't, really."

"But isn't what you've just described exactly the sort of thing that could damage a country's credit rating?"

"Yes. But like I said, it's unlikely. I have to go."

Remember, that was before GSE liabilities exploded and the U.S. government-through the Fed and the Treasury-piled on trillions in new liabilities to deal with the global financial crisis. Fast forward to IOUSA star David Walker's article in Tuesday's Financial Times.

"Long before the current financial crisis," Walter writes, "a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us."

Moody's rating service warned last January that if the U.S. government made no policy changes with regard to Social Security and Medicare, "we would have to look very seriously at whether the US is still a triple-A credit." At the time, Moody's said that "look" would come in ten years time. But we reckon with the huge explosion in U.S. liabilities via the TARP and the budget deficit, that look may come sooner rather than later. And when it does, all bets about the value of U.S. liabilities (bonds) are off.

Here in Australia, the three credit ratings agencies (Moody's, Fitch, and S&P) say the prospect of a $58 billion Federal budget deficit doesn't threaten Australia's credit rating. Not yet it doesn't. But don't be surprised if the question comes up later this year.

We suspect that government tax takings will be smaller than the budget forecasts. And the budget assumes the economy will have "above trend" growth of 4.5% next year. And of course, no one is planning for a government-bailout of commercial property, residential mortgages, or the corporate bond market.

Maybe all that seems a little far-fetched right now, especially when Aussie companies have been successful at raising new capital through the equity markets and the private bond market. But in 2003, a roomful of investment professionals and money managers found it hard to believe the credit quality of the U.S. government was at risk from growing deficits. They were wrong, and those deficits are much worse now. That's the fate Australia wants to avoid.

With debtor governments tapping the global savings pool to rebuild public and private balance sheets (or just hand out money) it reminds us of another idea we discussed in London in 2004: that energy is becoming a kind of capital. Russia's new National Security Strategy reaches the same conclusion.

The Kremlin's policy paper says, "The international policy in the long run will be focused on getting hold of energy resources including in the Middle East, the Barents Sea shelf and other Arctic regions, the Caspian and Central Asia." It then added, rather ominously, "Amid competitive struggle for resources, attempts to use military force to solve emerging problems can't be excluded."

Energy wars can't be excluded. But for equity investors-and just for the people of the planet-it would be better if oil stocks rose because the market was bidding up the oil price as opposed to, say, a border war in one of the "stans" over oil and energy.

And as we've written in our "Long Aftershock" report, there are plenty of structural reasons in the oil market (collapsing capital spending in 2008) to believe an oil supply crunch is around the corner. Either way-macro-economically or geopolitically-the stars are aligned for higher oil prices. Naturally, NYMEX crude oil prices fell to just under $58 in New York trading on Wednesday.

Dan Denning
for The Daily Reckoning Australia

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What a week it's shaping up to be. First, the Reserve Bank meets on Melbourne Cup Day Tuesday. And then Wednesday morning Australian time, we'll all watch the results come in from the U.S. Presidential election. Will either result be surprising?

The RBA talked up inflation last week, hoping to tamp down expectations for a big rate cut. The bank's deputies were out in public proclaiming the health of Australian household finances. Which households were they talking about?

The Australian economy has entered, "a new phase of weakness," according to a survey released this weekend by the Australian Industry Group. The report said this year's epic financial panic has led to, "rapid deceleration of orders, investments and confidence."

All that sounds suspiciously like a country that's about to enter a recession, despite the government's assurance to the contrary. Layoffs, falling house prices...none of that could ever happen here, could it?

Before we forget, if you want to watch an on-line, abbreviated version of I.O.U.S.A, the movie adapted from Bill and Addison's Empire of Debt, you can find it over at YouTube. No word yet on a DVD release date for Australia.

As current as the movie is, the Federal deficit has gone up about $2.5 trillion since it was made. Seriously. The various bailout programs and loans to deal with the credit crisis are growing faster than documentary film makers can up with.

The point of movie, however, becomes that much more compelling. You can't borrow your way to affluence and power and expect to stay there. You eventually transfer control of your economic destiny to your creditors. That's what's happening in America. And in Britain too, actually.

And who are those creditors? The people that make stuff and sell oil. China, Japan, and the Gulf States own a large chunk of America's public debt. And if you want a preview of what the relationship between these countries and America might be in the coming years, just take a look at Gordon Brown going hat in hand to the Saudis this weekend.

"The Gulf states will have a vital role to play in agreeing the plans to get the world economy moving again," Brown said on his way to Saudi Arabia this weekend. He added that the Gulf States "are an increasingly important source of inward investment to the U.K. As long as they play by our rules and operate in a commercial manner, we welcome investment from sovereign wealth funds."

What do you make of that? It's pretty audacious stuff by a man who is asking for money. But then, desperation often breeds a certain kind of boldness. The Gulf States, Brown says, "are an increasingly important source of inward investment to the U.K." Translation: you have the money and we need it.

And what about, "As long as they play by our rules and operate in a commercial manner, we welcome investment?" Let's have a crack at translating that.

"Yes, we'll sell whatever you're interested in buying (because we haven't), as long as you allow us to preserve the facade that we still own it and are in control of it. And it would be nice if the benefits of owning assets-you know, income, dividends, earnings-could still accrue to British firms and citizens...even though we don't own them any longer. Would that be possible? Would you like some tea? A scone?"

One of the most interesting things to watch in 2009 will be whether the authors of the beleaguered global financial system-the U.S., Britain, and Europe-will actually be able to redesign a new system and force it on India, China, Japan, and the Gulf States. The Old Money powers are certainly acting like it's their prerogative to redesign the world in any form they'd like.

But the New Money Powers-the oil exporters and the Chinese and the Japanese-might not be so content with a Global New Deal that preserves the power and status to the West without recognising...well...fiscal reality. It just goes to show you how complex relationships can get between creditors and borrowers. Who really has the power?

And then, who really has the power? That is, the American military has provided the law and order behind globalisation since the post-war era. Europe, Japan, and Korea subcontracted their defence arrangements to the U.S. And in exchange for basically going along with U.S. foreign policy, they enjoyed nearly unfettered access to the American market.

It looks like all that is changing in 2008. Not all at once mind you. But it's just a reminder that the current passage of calm in financial markets may not last too far into next year.

Dan Denning
for The Daily Reckoning Australia

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"I'm sure you've all had a chance to go through the bill the Senate passed last night 74-25. You can find it here.

"Of course, a spending Bill cannot originate in the Senate because as we know, Article 1, Section Seven of that useless piece of paper (the Constitution) says: 'All bills for raising revenue shall originate in the House of Representatives; but the Senate may propose or concur with amendments as on other Bills.'

"So the Senate lobotomized a Bill already passed by the House, which included, among other ridiculous spending provisions, Section 503 (EXEMPTION FROM EXCISE TAX FOR CERTAIN WOODEN ARROWS DESIGNED FOR USE BY CHILDREN.)

"According to Bloomberg : 'Senators attached a provision repealing a 39-cent excise tax on wooden arrows designed for children to an historic $700 billion bank rescue that is likely to pass tonight. The provision, originally proposed by Oregon senators Ron Wyden and Gordon Smith, will save manufacturers such as Rose City Archery in Myrtle Point, Oregon, about $200,000 a year.'

"Funny.

"But...there are some other portions of the Bill that look surprisingly bold, perhaps even illegal. I wonder.

"First, the totally legal but absurd increase in the statutory limit on the public debt, from Section 122: Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting '$11,315,000,000,000'.

"Seriously.

"Thank god for statutory law. If you don't like it, you can just change it.

"Other sections you might want to have a gander at include section 115, detailing the Secretary's 'Graduated Authority to Purchase.' Passage of the bill gives him $250b to play with. Then, if the President requests it and Congress approves, he can request as much as $350b. After that, it's $700bn, again subject to a request by the President and approval by the Congress.

"Please note, however, that $700bn is not the ceiling on the Plan. The language says $700bn is the most the President and the Secretary can request...at any one time.

"So this is bailout by installments. But $700bn is not the end. It is just the beginning, provided Congress signs off.

"And the rest of the section makes it hard for them to not sign off by severely limiting debate on the requests submitted by the President. You don't often see Congress agree on rules for floor behaviour in the House and the Senate in a Bill. The rules committee does that in the House and the Senate sort of makes it up as it goes along.

"But this bill specifies the entire process by which a request from the President (Bush or Obama) MUST be handled by the House and the Senate. No motions to reconsider. No debate.

"And Congress is even trying to cut out judicial review. That's in Section 119.

"It starts out promisingly enough by saying that 'Actions by the Secretary pursuant to the authority of this Act shall be subject to chapter 7 of title 5, United States Code, including chapter 7 of title 5, United States Code, that such final actions shall be held unlawful and set aside if found to be arbitrary, capricious, an abuse aside if found to be arbitrary, capricious, an abuse of discretion, or not in accordance with law.of discretion, or not in accordance with law.'

"But what is law anyway?

"Either way, Congress is severely limiting the circumstances under which the Treasury can be challenged. Is that legal? Just asking...not that it matters anymore."

Bill Bonner
for The Daily Reckoning Australia

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Before us is a clear and present danger. There is no doubt about it. Anyone who cares to look can see it. If something is not done to protect ourselves against it, the results will be either disastrous or fatal...we're not sure which.

This week, Addison's movie I.O.U.S.A. opens in 358 theatres across the nation. It is not merely a documentary film...it is also an expression of hope for our species. The question at hand - the real theme of this monumental drama - is whether a group of people can change the course of history.

You see, dear reader, the U.S. is in a fix. Nothing unusual about it - nations turn into empires (when they are unlucky)...then, they overstretch...they overspend...they overdo it. According to former U.S. comptroller - and the star of I.O.U.S.A. - David Walker, the U.S. government was in over its head by more than $50 trillion in 2007. Unless action is taken, the country will go broke.

Everybody knows that is true. But so far nothing has been done to correct the situation. Too many people in too many positions of power - including the lumpen voter himself - have too many reasons to want the system to continue unchanged. These people are getting something for nothing - and hoping to put the costs onto the next generation. But if the expenses continue to build up...the whole mountain of debt will come tumbling down.

Your editor is proud to have contributed to the movie. It was based, originally, on a book he wrote, with Addison, Empire of Debt. And he has a small speaking role in the film itself.

"I like what you say in the movie," says a friend who saw the preview. "But you look terrible. You look like a pervert."

In the film, we point out that empires always overstretch...and always collapse. Looking at history, we see that this story usually plays out as a tragedy - usually accompanied by defeat on the battlefield and national bankruptcy. Nevertheless, the Peterson Foundation is spending a billion dollars, according to press reports, to try to give our own "Made in the U.S.A." version of this old tale a happy ending. If people can be made to understand the problem, they will do the right thing...or so they believe.

And there is the question: can right-minded, well-meaning people really change the course of history? Is that the way it works...?

We will see, dear reader...we will see.

*** Meanwhile, in Lindau, Germany, a group of 14 Nobel Laureate economists have gathered to discuss the world's problems. Myron Scholes, who won his Nobel for his work on derivative pricing, said the financial crisis was "not over and I'm not exactly sure when it's going to be over." There will be "lots of business failures," he went on.

Joseph Stiglitz described the cause of the problem as a "massive failure of the brains of the economy."

Nobody was impolite enough to mention that many of the biggest brains were in the room...and that they had created many of the bubble's biggest delusions.

*** Our party ended last night about 3 AM.

"This whole place is like a giant pile of tinder...and everyone in the room has a match..." said Elizabeth. More to come...

Bill Bonner
for The Daily Reckoning Australia

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