Your editors here at The Daily Reckoning have no answers - especially when money is at stake - but we do have guesses. In fact, we have a lot more guesses than money. And so we would guess that the gold bull market is far from over...very far. But having said that, we would also guess that the risk of a sudden, steep correction is far from zero...very far. In fact, an imminent correction seems like a plausible scenario.

"Yes, we extract less and less gold ore every year," our colleagues in the French office point out. "And yes, there have been very few large gold discoveries in recent years. Yes, demand for gold bullion is exploding; Yes, central banks became net buyers of gold for the first time since the '70s; Yes, Asian demand is booming; Yes, gold benefits from the massive indebtedness of states, and the resulting increases in the money supply that destroys the value of paper assets and paper currencies... Yes, yes, yes...But something else struck me...everyone wants to own gold right now...That worries us."

And it also worries us, dear reader. Gold is popular, finally, and we just can't stand it! "Edgy" is not edgy anymore. The lunatic fringe has shifted to the middle of the bell curve. The financial counter-culture has become a pillar of the Establishment. This is not the world we knew in 1999, when we fell in love with $300 gold...and no one cared.

Between 1980 and 2000, the Yellow Dog did little more than gather fleas. Gold's value fell by more than half. During that same 20-year period, the S&P 500 delivered a dazzling return of more than 2,500%! Clearly, therefore, gold was a dead-beat, a good-for-nothing - more suitable for a Steinbeck novel than an investment portfolio. And like most losers, gold attracted other losers.

One of those gold-loving losers was The Daily Reckoning's very own Bill Bonner. As the new millennium dawned, Bill declared his "Trade of the Decade" - buy gold, sell stocks. The decade isn't over yet, but so far, so good. During the last nine years and 11 months, the S&P 500 has delivered a total return of -11%. The gold price has quadrupled.

And so, today, we find ourselves in a very different investment environment. Very few people on the planet believe that gold is a "Sell." In fact, lots and lots of people believe that gold is a "Buy"... Or least they say they believe gold is a "Buy." No doubt about it, the ancient monetary metal is back in style, which worries Bill Bonner a little.

"Everyone seems to be jumping on the gold bandwagon," Bill laments. "Frankly, it's getting a little crowded...a little top-heavy. It's making us feel, well, a little uncomfortable.

"Here at The Daily Reckoning we never met a crowd we wanted to join...or a line we wanted to stand in. We don't even like being on the winning side of a football game - too much boisterous company.

"No, give us the lost cause, the diehard and the underdog," says Bill. "We are much more at ease as an outsider...an outcast...an outlier. Not only is there more elbow room, that's also where the bargains are - where others aren't looking. Trouble is, almost everyone is looking where we're looking now. At gold.

"Ten years ago," Bill explains, "only the gold bugs - those few who were still solvent and still sane - bought gold. Now, the smart fellows are buying it too. People like David Einhorn and John Paulson. Heck, even central banks are buying it. For the first time in a quarter century central banks are buying more gold than they're selling.

"Why? Because the story is so good. So easy to understand. So convincing.

"If the recovery is for real, demand will increase, diminishing inventories and turning the Fed's hot money into consumer price inflation. Investors will turn to gold to protect themselves. If the recovery falters, the feds will increase their stimulus efforts, setting the stage for even greater inflation later.

"If this analysis is correct, gold is a one-way bet. The argument is good," Bill concludes. "We believe it. But it bothers us that so many others do too."

Bill is not bothered to the point of wanting to actually SELL gold. After all, as he readily admits, 'the argument is good.' Nor is your California editor inclined to make a case for selling gold. Here's the problem: Once you've sold the stuff, what do you do next? Buy stocks? Buy bonds? Buy vintage Coca-cola bottles?

And while you're thinking about what you might buy, what do you hold in your bank account? A currency that's depreciating faster than net worth in a divorce court?

So long-term gold holders are probably well advised to remain faithful to their favorite dollar substitute, and just ride through the inevitable ups and downs.

That said; short-term traders do not lack for reasons to risk betting against gold. For starters, the gold trade has become a bit crowded, as Bill correctly observes. Secondly, the recent rally has triggered "overbought" signals on all major technical indicators. Lastly, the recent rally is bumping up against the performance targets that have capped all the major gold rallies of the last ten years.

In the September 17, 2009 edition of The Rude Awakening (may it rest in peace), we presented the following table and observed:

"The shares of gold mining companies are flashing a compelling short- term buy signal. Since late July, the gold mining stocks, as represented by the HUI 'Gold Bugs' Index have jumped more than 30%, while the gold price has advanced only about one third as much.

"As the nearby table illustrates, rapid 30% rallies in the HUI tend to bode very well for the gold price. The five prior instances in which the HUI rallied more than 30% in a very short timeframe, the gold price subsequently jumped an average of 27%. A similar advance this time around would land gold at $1,160 an ounce by Christmas - or about $140 higher than today's price. No such rally is certain, of course. But the monetary stars seem to be aligning for both a short-term and a long-term advance in the gold market."

As it turns out, the stars aligned exactly as predicted and the gold price landed at $1,195 an ounce by Thanksgiving - a 30% jump from the mid-July lows.

As a result, gold is making more headlines than the soon-to-be-filmed love scene between Angelina Jolie and Johnny Depp. In fact, gold just might be the sexier of these two news stories...and that's probably not a good thing.

The long-term outlook for gold remains as compelling as ever. This bull market is justified and "has legs." But the Yellow Dog has run very far, very fast over the last few months.

The pooch might need a rest.

Regards,

Eric J. Fry
for The Daily Reckoning Australia

• We are Confident the Bull Market in Gold is Not Over
• Gold is in a Bull Market
• Less Gold is Being Sold by European Central Banks
• What is Short Selling?
• Stock Market Collapse Can Be Explained By Panicked Forced Selling

"Okay."

"Why so serious? I mean, all you do every day is write about the worst-case scenario. It's depressing. Who died and made you the harbinger of financial doom? How about something positive for a change?"

"Is that code for, 'buy me another beer?'"

"No, seriously. It's not all bad all the time is it?"

We'll tell you how we answered our friend's question below. But first up, the markets. It was another red day in New York, with Dow stocks down over one percent. Tech stocks on the Nasdaq - the ones enjoying a bit of euphoria renaissance - were down 2.67%. September new home sales in the U.S. fell 3.6% from the month before. The Aussie dollar shed 1.44% against the greenback.

Is that all just noise? Or is there a melody building in the markets? The chorus chanted by Ken Henry, Wayne Swann, and most of the media is that the strong Aussie dollar, the strong market, and the strong(ish) economy are all factors of Australia's great policymaking and unique relationship to the China boom.

But the alternative tune - the one which we've been humming - is that most of the rally in stocks since March and most of the 30% rise in the Aussie dollar is a result of the carry trade. Yes, Aussie assets are relatively more attractive when the cost of capital in the U.S. is zero. But this can change in a flash when foreign speculators change their trading minds.

That's just what happened last year. Only then, it was both a dollar and yen carry trade that led to a rise in Aussie assets. Once the credit crisis set in, the yen carry got dropped and investors fled risk assets and piled right back into the greenback and U.S. Treasuries. Stocks fell, commodities fell, and the Aussie dollar plummeted to nearly 60 cents against the USD.

It doesn't have to happen that way now just because it happened that way then. But since our main job here is to question conventional wisdom and offer you an alternative explanation, that's the one we're offering you. Beware carry trades promising false permanent prosperity!

But what about today's earnings? ANZ followed up yesterday's bad debts bonanza from NAB with one of its own. ANZ reported an 11% fall in net profits (to $2.94 billion) and a 46% rise in bad debts to $3 billion. But both banks hinted that the end of the "bad debt cycle" is over and that things can only get better.

Let's take the other side of that trade. Again we'll focus on two risks: access to foreign funding and asset values on the balance sheet. ANZ sourced more of its funding from domestic savers and less from short-term whole sale funding, according to its report. Aussie savers funded 55% of ANZ new loans for the year (up from 50%) while the company reduced its reliance on short-term whole sale funding by 17% (now just 17% of all funding).

What does that mean? It means the company is making plenty of new loans (you'd want to, especially to the housing market, to prop up the value of your real estate portfolio). But it means the company is relying a lot less on short-term borrowed money from overseas in order to boost lending to Aussie homes and businesses.

Whether it is doing this by necessity or by choice is big question. But all we want to point out is that if your economy relies on imported capital to finance investment (or consumer spending, or new mortgage lending) you're vulnerable if that capital is not forthcoming. It's great when the dollar is high and capital is flowing. But if those capital flows reverse, the banks may find themselves in a jam that even a government guarantee makes it hard to escape.

It's not just us saying this, by the way. "We need to figure out how we can become less dependent on wholesale funding to finance our economic growth," said Commonwealth Bank of Australia chairman John Schubert in last Friday's Australian Financial Review. "It is not assured that we will get the funding into the future."

No foreign funding, no continued housing boom. In fact, we'd be willing to say that a cut off from short-term wholesale foreign funding is just the sort of thing that could lead to a major correction in Aussie house values. Naturally, the government here would step into the mortgage finance market in a big way, and not just for non-bank lenders, as it's done with the Australian Office of Financial Management buying securitised residential mortgage backed securities.

The U.S. government has done everything it can to keep the mortgage credit flowing and household net worth from imploding. Australia would do the same if it had to. But like in the U.S., this means more government borrowing to prop up the property market. More debt, higher interest payments, less capital available for lending to the rest of the economy.

But let's assume for now the public sector does not enlarge again to Depression-era levels of debt. Let's assume that Aussie banks have access to overseas credit. There is still the issue of asset values. ANZ says it is leveraged about 17 to 1. With $476 billion assets, that leaves it with about $28 billion in equity (according to how it calculates both assets and equity). And like yesterday, it's fair to say that a few billion in loan losses and bad debts are hardly the sort of thing to wipe out that much equity.

That's not where the real risk is, though. The real risk is to the asset portfolio. Twenty eight billion in equity capital is just under 6% of total assets. Or, put another way, a 6% loss in assets wipes out the equity.

A six percent loss in assets? Is that possible? The IMF and APRA have stress tested Aussie banks for scenarios in which large chunks of homeowners can't pay their mortgages. They chuck in large corporate bond default rates just to make things more stressful. And after all that, they've concluded that most of the banks' assets are solid and safe and unlikely to incur mammoth losses that would jeopardise the equity capital (solvency).

And maybe they are right. But we're just saying...in a world dominated by massive credit write downs...where we have just seen six months of re-leveraging...and where house values here in Australia have managed (thus far) to escape massive deflation...is a six percent loss on assets totally unimaginable?

We can imagine it, although we don't relish it. Either way, we wouldn't buy the banks just now.

But if you're looking for the most over-valued asset class in the world - the one worth a punt for going short - it has to be U.S. government bonds. Paolo Pelligrini, the man who helped John Paulson make a mint shorting the U.S. housing market, told Bloomberg that shorting long-term U.S. debt is the "only attractive bet" going at the moment.

"I always like to think about assets that are likely to experience a breakdown; the only thing I'm pretty comfortable with right now is U.S. Treasury securities and U.S. agency mortgage-backed securities...I think that those are overpriced so they are attractive shorts."

If you're not going to short the U.S. long-term bond market any time soon, the take away from this is to look for assets that go up when U.S. bond prices fall. If U.S. bond prices fall it means U.S. interest rates go up. That might, for a bit anyway, lead to a stronger USD and a weaker AUD.

For a trader - other than cash and gold - we'd look to see which of those Aussie stocks hammered by the stronger Aussie dollar have been beaten down the most. They might be due for a quick rebound - although they will be fighting the general trend in the market. We'll ask Murray what he thinks and get back to you.

So what did we tell our drunk friend when he asked us why were so critical, sceptical, negative, and gloomy all the time?

"Relax dude. It's my job to plan for the worst case scenario. It makes me happy to have a purpose in life. If you want the best case, turn the TV on and turn your brain off. And I object to your overly negative characterisation of my work."

"Huh?"

"My work isn't negative. It only seems that way because we live in a period of wealth destruction. I wish it were a world of wealth creation. But in a world of wealth destruction, you have to focus on preserving your wealth and maybe, when you can, growing it if you've got the big picture sorted out correctly."

"But you make it sound like the end of the world every day."

"It is the end of the world every day. But it starts all over the next day. And it is just the end of the financial world as we know it. Not the end of the world world...Besides, it's a lot less scary when you face up to what is really going on and make a plan for it. Uncertainty is scarier than risk because with uncertainty, you have no idea what to expect. Risk you can at least manage."

"But how can you be so sure you're right about the big picture? Everyone else I talk to says there's no way the dollar is going down as a reserve currency and that only kooks believe that. Are you a kook?"

"Certified. But that doesn't mean I'm wrong. You can't keep adding debt forever to fund your way of life. Debts have to be repaid. And interest has to be paid on the money you've borrowed. The politicians in America keep making new promises they aim to keep with borrowed money. This borrowed money is massively interest rate sensitive. And it's in addition to a huge amount of money they've already borrowed. It's the end-game for the whole financial/fiscal/political model."

"But so what? Isn't everyone else doing the same thing?"

"Well yeah. All fiat money is a scam. It's a way for the government to run perpetual debts and steal savings through inflation. It's an immoral living arrangement in that respect. But more importantly, from a financial perspective, it's a way of funding a political arrangement. And that way of funding it - borrowing more and raising taxes on a small productive class to pay for a larger public sector - is every bit as dead as the funding model for investment banks."

"But the government bailed out the investment banks. Who is going to bail out the government?"

"No one. Nothing. It will try inflation. But that doesn't work. Printing more money to pay off your debts just destroys wealth. That's where we're headed. That's what you should plan for. Sooner, not later."

"I would like to begin my plan with another beer, if it's all the same to you."

"No worries."

Dan Denning
for The Daily Reckoning Australia

• Aussie Banks Addicted to Foreign Borrowing
• IMF Report Concludes Aussie Banks are “Very Sound”…
• A National Mortgage Bubble
• Fed Now the Middle Man in Interbank Lending Market
• Borrowing and Paying Back in a Foreign Currency

The dollar has been the "Coca-Cola of monetary brands," says James Grant, editor of Grant's Interest Rate Observer. But even the best of brands can be lousy investments. Grant uses the analogy of The New York Times. It was the greatest name in newspapers. In 2002, the stock sold for $53 per share - an all-time high, as it turned out. Today, the "Gray Lady" fetches only $8 per share.

"What happened?" Grant asked. The World Wide Web happened, he says. "The Times has hundreds of reporters, but this is a story they seem to have missed." As if the lowly stock price was not evidence enough of its decline, the NY Times got another reminder when it borrowed $225 million against it headquarters building. The cost of such borrowing, Grant reports, was 14%. The august Times today borrows at rates no better than a working-class stiff at a pawnshop. The US Treasury should take note. The government seems as intent on creating dollars as prolifically as bunnies create other bunnies.

Here we get to John Paulson, a presenter at the Grant's Fall Investment Conference and undoubtedly the richest man in the room. Portfolio magazine dubbed him "The Man Who Made Too Much" after he made $3.7 billion by betting against mortgage-backed securities (MBS). He is one of the greatest hedge fund managers ever.

Gold is his favorite today. As to why, Paulson presented a simple, but compelling case. First, the monetary base has exploded in a way we've never seen before. The monetary base is essentially the Federal Reserve Bank's currency and reserves. The Fed, by buying up securities in this crisis, has pumped a lot of money into the economy.

You've probably seen this chart, or some variation of it. Still, there haven't been noticeable signs of inflation as a result of that big spike - not yet.

As Paulson explained, that's because this base money has not yet been lent out and multiplied throughout the economy. Yet the monetary base and money supply are highly correlated, "almost 1-to-1 between the two," Paulson said.

That means that as the monetary base expands, the money supply surely follows, though there is a lag. (Money supply is a broader measure of money than just the monetary base, as it includes personal deposits and more. The monetary base is like a kind of monetary yeast. It makes money supply rise.)

If money supply grows faster than the economy, that will create inflation, says Paulson. As it is impossible for the economy to grow anywhere near that vertical spike in the monetary base, Paulson contends inflation is coming.

The US is not alone in its money-printing exercise. The supply of most currencies is expanding rapidly - even the normally tame Swiss franc. In the race of paper currencies, they are all dogs. Hence Paulson's interest in gold, which no government can make on a whim.

Therefore, in the content of the exploding monetary base, gold seems relatively cheap. In other words, as the money supply rises, so does the price of gold, eventually. As a result, says Paulson, "gold has been a perfect hedge against inflation."

There is some slippage over time. The gold price can change faster or slower than the money supply. But when the market gets worried about inflation, the gold price usually changes much faster - as happened in the 1970s. In 1973 - to pick a typical year - inflation was 9% and gold rose 67%. That was a pattern common in the 1970s.

The potential for inflation this time around is greater than it was in the 1970s, given that the growth in the monetary base is so much greater than it was in the 1970s. Gold could do much better this time around, reaching "$3,000 or $4,000 or $5,000 per ounce" as Paulson said.

I keep thinking how future historians will look back at the present day and see clearly how this unfolded. They will see the litany of news items that pointed to the dollar losing its top perch: China and Brazil settling up trade in their own currencies. The Russians and others openly calling for a new monetary standard. Even mainstream outlets are discussing alternatives to a dollar-based standard, a province once solely occupied by cranks and gold bugs. Not a week goes by without these kinds of stories.

As for a replacement waiting in the wings, Grant offers up gold. Indeed, a kind of "de facto gold standard" seems to be taking shape. The SPDR Gold Trust, the largest gold-backed security in the world, is now the sixth largest holder of the metal in the world. Anybody with a brokerage account can easily buy gold today through the trust, which trades on the NYSE under the ticker GLD.

It's still early. Most people still own no or very little gold. As it becomes clearer what's happening, they will buy more gold, especially as it is now easy to do so.

The gold supply, too, is limited against the vast pool of dollars. As Paulson points out, global money supply is 72 times the value of gold. I'm betting that gap will narrow. It only has to narrow a smidgen and the gold price flies.

As Grant eloquently put it: "Gold is a speculation. But it is a speculation on a certainty: the debasement of the currency." Gold stocks, too, are a speculation. But they are a speculation on an inevitably higher gold price.

Regards,

Chris Mayer,
for The Daily Reckoning Australia

• Does Gold Do Anything But Rise?
• Dollar Rally the Sort of Thing that Will Lead to Correction in Gold Price
• A Gold Standard, Without Gold
• Fannie and Freddie in a Free Market Economy
• The Destruction of the Dollar by the Federal Reserve

What a day. Under cover of the AIG scandal, the Fed did something foolhardy yesterday.

"Fed plan stuns investors," says the headline in the Financial Times this morning.

It should stun us all. But we're getting used to expensive bamboozles.

In response to the Fed's latest move, the yield on 10-year Treasuries fell more than any time since they started keeping records in 1962. From 3.01% it had fallen to 2.48% when last we looked.

Yields fell because the Fed said it would buy $300 billion worth of government debt. Stocks rose - with the Dow up 90 points. And the dollar fell heavily against the euro...down to less than $1.31/euro.

Of course, most people have no idea what this means. But here at The Daily Reckoning we weren't born yesterday. And we've been following this story for the last 38 years.

Yes, dear reader, when Richard Nixon cut the link between the dollar and gold, the world has been using a money system that is, to put it in its best light, experimental. The last experiments of this sort - on anything like this scale - were conducted in the 18th century. The Banque Generale was set up by that rogue, John Law, to buy up the debt of France - of which there was plenty. And a similar plan was underway in England soon after - later known as the South Sea bubble. It was similar in that the bank substituted pieces of paper - stock in the South Sea Company - for government debt.

In the U.S. version, circa 2009, the Fed uses pieces of green paper called 'dollars' to buy up the government debt.

Wait a minute...where do the dollars come from? Oh, silly reader, they come from the same place that shares in the South Sea Company...or shares in the Mississippi Company (the French version) came from - they just printed them up!

And now, they don't even have to print them up. When the Fed buys U.S. debt, it merely makes an electronic notation...like an IOU that disappears as soon as the power goes out.

When those 18th century debt buy-up schemes were put in place, at first their stock rose. John Law's shares were such a hit that ladies would stop him in the street...it was rumored that they offered their most cherished favors in exchange for an opportunity to buy. Shares in the South Sea Company, meanwhile, went up 10 times in a single year.

U.S. bonds rose strongly yesterday too; of course, the richest investor in the world just entered the marketplace - announcing he would buy $300 billion.

And if that doesn't work...he'll buy more.

"Fed to buy $1 trillion in securities to aid economy," reports the New York Times.

"The Fed is engaging in massive quantitative easing," said William Poole, former head of the St. Louis Fed.

And why not? The central banks of England, Japan and Switzerland are all buying their government bonds. The IMF too.

Besides, all the bailouts and stimulus plans so far haven't worked. And at least this latest plan makes a little more sense. The problem is debt, not liquidity. Buying up the securities of Fannie and Freddie, the Fed will lower the cost of mortgage debt. This will give homeowners an opportunity - probably the last one of their lifetimes - to refinance their houses at low interest rates. The target range...we've heard...is between 3% and 4%.

In the short run, if the homeowner is able to refinance at such low rates, he reduces his monthly cash-flow burden and frees up cash for other things (such as paying down his credit card debt). In the long run, if he's able to lock-in those low rates, he will almost certainly see the debt burden itself significantly eased - thanks to rising inflation rates.

Lenders beware! U.S. Treasury bonds are attractive because they are safe. But they could turn out to be the riskiest safeguard in financial history. This is a moment when it is probably better to be a borrower than a lender. Refinance your house at 5% fixed rate. For the first few years, paying that mortgage may be as painful as marriage counseling. But then, when the marriage finally breaks up...and inflation heads to 10%... think how free and easy you'll feel. In a few years, your mortgage will practically disappear.

This is so attractive; we're tempted to do it ourselves. But we haven't had a mortgage in 20 years...we don't want one now.

Better to follow the smart money. John Paulson is one of the few hedge fund managers to understand the financial crisis and to make money in it. He made a fortune betting against subprime in 2007. In 2008, his fund was up 37% - while the rest of the world lost trillions.

What's he doing now? He was in the news this week, because he bought a big stake in a gold miner - AngloGold Ashanti - for $1.28 billion.

Gold went down yesterday...and then bounced back over $930.

"The dollar took a major hit after the Fed announced that it will be buying more government bonds and mortgage backed securities - that's another 1.2 trillion in 'new' currency hitting the money supply," writes our intrepid correspondent, Byron King. "The announcement created a frenzy in the gold market. The price of gold shot up $50 per ounce less than 2 hours after the feds meeting."

"Precious metals are like fire insurance. You don't wait until you smell smoke to call your agent and buy coverage."

Given yesterday's announcement, it's surprising that it is not already over $1,000 an ounce. Perhaps it soon will be...in which case, we urge you to get in now, while the price is still relatively low. We think we're going to see the yellow metal much, much higher.

Now over to Addison, reporting from Charm City...

"In a single breath the Fed committed another $1.15 trillion to the credit quagmire," writes Addison in today's issue of The 5 Min. Forecast.

"The dirty details:

"* $750 billion for purchasing mortgage backed securities from Fannie Mae and Freddie Mac (on top of the $500 billion the Fed has already promised).

"* Another $100 billion directly toward Fannie and Freddie's debt. That's also atop a pre-existing, $100 billion program.

"* The knockout blow... the Fed will officially begin buying 'longer term' U.S. treasury notes. The FOMC said they'd spend at least $300 billion over the next six months.

"Yesterday's announcement could easily balloon the Fed balance sheet to over $3 trillion," continues Addison. "We expect that to go even higher by the end of 2009. These are 'up to' numbers, mind you. So it may never happen. But the Fed did choose them for dramatic effect. Likewise, we thought we'd show you a chart of the Fed's balance sheet, if it ballooned as dramatically as last fall:

"The Feds statement reads 'the Committee expects that inflation will remain subdued.' Phew."

Addison writes every day for The 5 Min Forecast, an executive series e- letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less.

And back to Bill, reporting from Paris, France...

Those poor English. If any people were dumber at finance than Americans, it was the English. While debt in the United States rose to an unprecedented 350% of GDP, in England it went to 500% of GDP. And now joblessness in Britain has risen above 2 million for the first time since 1997.

House prices were outrageous in the United Kingdom - but they're becoming less outrageous by the day. One expert says he expects them to fall another 55% before hitting bottom.

Meanwhile, here in France, the chiselers and whiners have taken to the streets. Today, there's a big strike going on - supposedly. We didn't see any signs of it on our way to work. But the French are said to be up in arms because of the financial crisis.

France is an importer of tourists and an exporter of luxury items...and high technology. The Russians are broke, so they're not spending billions on French champagne and fashions. Americans are broke, so they're not filling the restaurants the way they did last year. The English are broke, so they're not buying little houses in the south of France. The airlines are losing money, so they're not buying French planes. And so forth...

"Class war," the Financial Times calls it. Factories are closing. Layoffs are increasing. The unions have organized to protect jobs. And the government is doing a bad job of lying. It has bailed out the banks...but failed to pretend to bail out the little guys too.

We'll let you know how this develops...

But today's headline story is still the AIG scandal.

"Give us back our money," yelled a protestor at Edward Liddy, AIG CEO, yesterday.

The taxpayers are upset. The politicians are pretending to be upset. And the media thinks it has a hot story.

But what is remarkable is that the public has an opinion about how much insurance executives should be paid. Whenever the public has an opinion on something that should be a private matter, you can be sure there's a bamboozle in it somewhere.

"Street of Shame," writes an editorialist in the FT. AIG bonuses are a "humiliation for Wall Street and a travesty for the taxpayers."

What they really are is a huge distraction. The insiders are making off with billions, while the watchdogs are yapping at a handful of over- paid insurance hacks.

David Leonhardt, writing in the New York Times:

"I looked into every large company that had changed chief executives over the previous six months. Not a single boss at any of them had left for another job. Such departures are so rare that Booz & Company's annual study of executive turnover doesn't even include a category for them. The benefits of the job - the pay, the perks, the gratification that comes from running a company well - are too good to leave, even for a similar job.

"The situation is a little different for jobs below the top level, particularly on Wall Street. Surely, if the employees of AIG's notorious financial products division were to be denied their bonuses - a big chunk of their annual compensation - many might leave.

"The nub of Mr. Liddy's argument is that these departures would be a terrible thing. But there are several weaknesses with this argument.

"The first is that the original explanation for these bonuses was rather different. When they were devised in early 2008, months before the first bailout, as Mr. Liddy's letter to the government on Saturday explained, 'AIG Financial Products was expected to have a significant, ongoing role at AIG.' The idea, he said, was to guarantee 'a minimum level of pay for both 2008 and 2009.' So the rationale for AIG's retention bonuses is as malleable as the rationale for chief executives' bonuses.

"Most amazingly, the AIG bonuses haven't even accomplished their stated goal. Andrew Cuomo, New York's attorney general, said Tuesday that 52 employees who received bonuses had since left AIG.

"The second problem with Mr. Liddy's argument has to do with Mr. Liddy himself. His defenders have noted that the government brought him out of retirement to fix AIG and that he presumably puts a higher priority on doing a good job than pleasing AIG's employees.

"And he probably does. But he is also a product of the current, broken executive pay system. As the chairman of Allstate from 1999 to 2007, when the company's stock underperformed those of its rivals, he made $137 million. Almost $14 million of that, according to the Corporate Library, came in the form of stock that the company called a 'a tool for retaining executive talent.' Which means Mr. Liddy may not be entirely objective about retention bonuses.

"Finally, there is the question of how hard replacing those AIG employees would be. Certainly, some of them must have particular insight into unwinding the toxic portfolio they built. But I doubt that anywhere near all 418 financial products employees - who have received bonuses worth $395,000 on average - are indispensable. "

Mr. Leonhardt is right. But he is missing the point. Companies should be able to pay their employees however much they please. They should be able to go broke too.

That's how capitalism is supposed to work.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Feds Buy Houses
• The New Capitalists Were Not Real Capitalists
• What Did the Feds Think When They Gave AIG Money?
• Government Pretends to Punish the Bankers
• Free Market Capitalism, The God That Failed