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

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

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

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

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

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

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

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

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

Is that so?

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

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

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

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

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

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

Dan Denning
for The Daily Reckoning Australia

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

The $2.5 billion listing of Myer is expected this week. And what better way to celebrate a six-month reality-defying rally than the listing of a consumer-driven business? Happy days are here again!

Not that we have anything against Myer. It's a good store. We recently bought a sweater there to get us through Melbourne's Antarctic spring. But you know our position here at the Daily Reckoning.

You don't wash out twenty years of mis-allocated credit with a mild recession and then return to the glory days of the stock market. We are still in the middle of a large deflation in credit-backed financial assets. The Myer listing may give the index a boost. But it's not going to change the big picture.

The big picture is that across the Western world consumers are dialing back the spending and turning up the caution. A sea change in attitudes about the future is taking place. For example, the U.S. Commerce Department reported that durable goods orders fell in August by 2.4%. Take away government subsidies for new cars and households are not buying big ticket items.

And then there's housing. Existing home sales fell by 2.4%, the first decline in five months. Here's a warning: watch out for a second massive wave of foreclosures in U.S. housing. U.S. banks, thanks to a relaxation of mark to market accounting rules, have been able to put off the day of reckoning on what to do with millions of non-performing loans. That day, though, is coming.

There are other looming issues like commercial real estate. But we know you must be tired of hearing all that. After all, that is America, not Australia. It would be much easier if we quoted the impossibly smug Kevin Rudd that the government has saved the day. But that just ain't the case.

By our reckoning, the second dip of the global downturn is upon us. Government policy (monetary and fiscal) has merely lured people into believing there is no real cost for decades of bad investments. But the truth is that a lot of stock analysts and economists have simply miscalculated the magnitude and severity of what happens to the real economy when the world's largest ever credit bubble bursts.

Of course we could be wrong. Nobody knows what's going to happen. You hedge your bets and continue to plan for the future. But we're about to find out if we've been living through a modern version of 1930, when a false recovery in the economy was the prelude to the "Great" part of the "Great Depression."

Maybe this will sound like a bunch of whining by the end of the week. After all, three of the big four Aussie banks will report results this week. There will be billion dollar cash profit figures tossed around. But as we said last week, the earnings performance of financial firms in the last six months is a sham.

Cost cutting, government loan guarantees, and an infusion of central bank credit allowed all the big financial players to trade their way to profits for a few quarters. What we don't expect to see is that the Australian banks are suddenly keen to expand their loan books or that their underlying businesses are fundamentally better now than they were twelve months ago. A simple question: just where will the profits come from now?

In the meantime, keep an eye on oil. Sometimes the oil price is driven by speculators. Sometimes it's driven by expectations for the economy. And sometimes it's driven by flat out geopolitical fear. We think now could be one of those times were geopolitics drives crude. Why?

We got a note from a commodities trader in Chicago over the weekend. Up at three a.m. as we're getting over our jet leg we read, "In the big geopolitical dance that has dominated recent headlines there remains one player that all the action seems to swirl around. That player is Iran.

"President Obama's announcement of the discovery of a second 'secret' uranium processing facility with shouting distance of the Shiite holy city of Qum has raised the stakes in what is quickly becoming a very dangerous game. If you read between the lines, nearly all of the geopolitical maneuvering over the past few months has been about the same thing.

"Obama dumps Bush's land-based missile system for a sea-based one that poses far less threat to Russia. Russia - without admitting it, of course - then becomes more accommodating to sanctions against Iran. Israeli Prime Minister Netanyahu goes to Russia without telling anybody and gets caught doing it. Why?

"Certainly not to talk about the weather. We believe Netanyahu was there for a specific purpose: to warn Russia what would happen if Iran did not stop producing bomb-grade uranium. We also believe Obama's controversial move was designed to give Russia political cover to pressure Iran to do just that. Now that a second uranium-producing facility has been found, the stakes have risen again.

"If some sort of political solution to the Iran crisis is not found within the next few months, Israel will strike - with or without the 'permission' of the United States and the price of oil will react accordingly. The global slowdown is currently focusing all the attention on demand, but the biggest bullish factor out there is ultimately, supply. Remove Iranian oil from the market and the old highs of $147 per barrel could be tested quickly.

"Is this going to happen? We hope not. However, our read of the geopolitical events of the past few months makes us think it could be a distinct possibility.

Dan Denning
for The Daily Reckoning Australia

• Iran Suffering from Own Version of Peak Oil
• Latin America Has Suddenly Become Very Interesting
• Are Farm Prices Destined to Rise as More People Compete for Food?
• No Spike in Oil Price Following IEA “Third Oil Shock” Announcement
• Price of Oil May Rise Due to Scale of Georgian Conflict

But first, we were poring over the reader e-mail last night. Many readers think we are being unfair, unconstructive, and un-brief in our critiques of Ben Bernanke, bankers, Kevin Rudd, and other economic know-nothing from across the political spectrum. So let us take a moment to be as clear as possible: policy makers and politicians are morons.

We're told Ben Bernanke is the right man to get us out of the trouble we're in. But isn't Ben Bernanke the man who got us into the trouble to begin with? Didn't he and Alan Greenspan lower interest rates so much they created a worldwide credit boom that is now deflating? Wasn't it their policies that enabled banks and Wall Street to securitise commercial and residential mortgages and send them far and wide into the balance sheets of the world as "assets"? And aren't those "assets" now falling in value, continuing to wipe out equity at the household and corporate level?

It is clear that politicians are still slovenly serving the interests of their corporate masters in the financial world. And it is clear that the financial world has every reason to encourage government stimulus, loan guarantees, and lower interest rates. This keeps the great leveraged credit machine of the Financial Economy motoring. And that machine keeps the financial industry in tall cotton.

Besides, the limits on executive compensation are window-dressing for public (voter) consumption. With bonuses limited by statute, we reckon more compensation for the financial industry will move back to stock option grants. That means for the financial industry to preserve its privileged status, stock prices have to move higher. And nothing enables that like credit. Borrow money and plough it back into stocks to line your pocket. Does that sound like something that may be happening?

Our point is that this whole interlude since the collapse of Lehman Brothers is an attempt to preserve the status quo ante. If the tools of monetary and fiscal policy (which are clumsy and theoretically flawed anyway) exist to make the financial and estate industry thrive, the real economy will continue to get screwed. We'd argue this recent recovery is nothing but an attempt to resuscitate the money-shuffling arrangement that was so profitable up until late 2007.

At least some people agree. "A UN think tank on trade has warned that the current financial market rebound is not a 'real recovery' and that any world economic growth recorded in 2010 was unlikely to exceed 1.6 per cent," reports today's Australian.

"The depth of the recession has been so important that of course there will be a rebound ... but we still do not see that this is a real recovery," says Supachai Panitchpakdi, secretary-general of the United Nations Conference on Trade and Development (UNCTAD). "The actual increase in the commodities prices is mainly driven by appetite for more risk," he says. More on this in just a second.

UNCTAD's Chief economist Heiner Flassbeck, said, "the markets had been fuelled by financial speculation that in turn was driven by expectations of recovery. 'But anticipation of recovery is just a fiction, it is not there.'"The UNCTAD report also noted that, "Tumbling profits in the real economy, previous over-investment in real estate and rising unemployment will continue to constrain private consumption and investment for the foreseeable future."

Hmm. Maybe UNCTAD is reading the Daily Reckoning. But if not, for those who have eyes to see it, the truth is plainly in sight. You cannot correct the global imbalances of a leveraged boom with more leverage. But let's tackle on specific aspect of the report that suggests commodity prices may again be the subject of financial speculation. Is it true?

Frankly it's hard to say. We're more confident that profits in the real economy - once you take away the effect of credit and government money - are regressing to an historic mean. Some companies will make more. Some less. But the average will be lower.

However we did see one interesting chart yesterday from our trader Gabriel Andre. We were discussing with him whether the euphoria about Australia - the dollar, the stock market, real estate, and commodities - was suspiciously reminiscent of June 2007. You know, right before the ore hit the fan. Is all this feel-good news a sign of worry?

We decided to tackle the question with a picture. It's the chart you see below. The chart tracks the performance of Worley Parsons - a proxy for infrastructure and capital spending in the mining industry - versus the CRB commodity index. We are asking a question with this chart. The question is, does a peak in Worley's stock presage a downturn in the resource sector generally?

Click to enlarge

Gabriel writes that, "The level of $30 looks as a strong resistance for the stock. It's a previous low where it bounced back several times in 2007 and 2008. The recent action suggests the $30 may be a new high, finding resistance, especially because the correlation is obvious with the CRB and the CRB has already started correcting.

"If you pay attention to the details on the chart, it looks like the correlation is stronger on the downside. Worley can fall when the CRB rises. But when the CRB falls, Worley generally falls too. If you were asking me to turn this observation into a trading idea, it would be to short-sell WOR at the current levels with a stop-loss at $31. A correction towards $20 is possible.

Gabriel has been working on a system to trade these chart patterns in ASX 200 stocks for the last four months. Look for more information on that later this week. And in the meantime, keep in mind that if Worley is a proxy for the bull market in Aussie resource stocks, the charts are suggesting that all the positive momentum since March may be reaching its limit. When you check in the turn down on the CRB, you should be prepared for the possibility of a correction in commodity prices too.

If that happens, it would be perfectly consistent with the tenor of the news these days. As excited as we are ourselves about certain resource projects, the level of bullish consensus about commodity prices and corporate earnings is a warning sign. But - this is important - that doesn't mean you have to head for the hills.

As Gabriel's work is showing, you can use these kinds of signals to take profits before rallies expire. It can also save you from mis-timing your entry into a blue chip share. And ultimately, it should be able to help you identify the best time to get back into the share, after the inevitable correction has done its work.

We meant to write more about gold, sound money, and unsound economic thinking. But that will have to wait until tomorrow. Until then...

Dan Denning
for The Daily Reckoning Australia

• CRB Index Correction Likely to Go Further
• Worley Parsons (ASX: WOR) Announces Pilbara Solar Energy Project
• Note to Australia: Buy Resources, Not Banks
• Government Preparing Another Stimulus
• Recovery for the Real Estate Market

There was quite a bit of snarky e-mail yesterday criticizing our comparison of gold to the S&P 500 over the last ten years. "Your time periods are arbitrary!" "You only picked dates that would support your argument!" "Housing has done better. So has oil. The Aussie gold price is up less than the All Ords! Why not just buy BHP and hold?"

So many critics! But a few of them may have missed the point, we'd humbly suggest. Of course you can cherry pick dates to support your argument for the performance of one investment over another. But that wasn't our point, or our intention.

Our point was that at certain moments in the life of markets, you witness long-term trend changes. One secular bull market ends while another one might begin in a different asset class. Gold began a secular bull market in 2000 just as stocks ended an 18-year bull market. That's why the trade of the decade was to buy gold and sell stocks.

Those are the kinds of sea changes you have to be aware of if you're going to make money as an investor. This doesn't exclude making money in other ways or other asset classes. But it's useful to know what the primary trends are moving the market-especially since a huge portion of your total return in any investment comes from being in the right asset class (and not stock selection).

So yes, there is more than one way to skin a bull. By all means, buy BHP if you want to invest in the long-term commodities bull. We recommended BHP shares to readers of Strategic Investment back in 2003, for example. Even then, we were a bit late to the trend. But the important thing was investing along with the big trend.

Just to be clear though, the big trends now are soaring inflation and falling financial asset prices, along with increased energy scarcity. This produces a variety of pair trades, which include: short government bonds, long energy, short residential housing, long gold, and probably short commercial real estate and corporate bonds as well, while going long farmland and agriculture. But how corporate bonds fare in the coming months depends a bit on the aforementioned government bond yields. So let's get stuck into them, shall we?

Over in America, ten-year yields advanced to their highest level since last October. It happened just as Uncle Sam was throwing an additional $19 billion of ten-years over the line and into the battle against deflation. The sale of the bonds took place at an average yield of 3.99%.

Tomorrow is the auction for $11 billion in 30-year bonds. Thirty-year yields are already as high as they've been since October of 2007. And by extension, borrowing costs linked to government bond yields will rise too. Mostly this affects the U.S. mortgage market. It means that refinancing a mortgage-providing you can find a willing lender-will get more expensive.

But we think rising U.S. bond yields indicate that the Credit Depression is entering a new phase. The cost of capital is rising, after slumping to historic lows during the credit boom. Investors-including other sovereign nations-will demand higher yields to loan to deficit-challenged governments. Or they may just dive into asset classes with better growth prospects.

For example, Russia's central bank says it may switch out of U.S. bonds and into IMF bonds. Russia's Finance Minister Alexei Kudrin says Russia will buy $10 billion in IMF bonds. China floated a trial balloon earlier in the week about buying $50 billion in IMF bonds. Brazil said it will buy $10 billion worth of IMF bonds.

This is just the beginning of the beginning. Or maybe it's the middle of the beginning. Or it could even be the end of the beginning. But it's pretty clear that the balance of power in the global financial system is shifting. It favours real resource producers and creditors. It does not favour governments with big deficits and bad demographics (more recipients of governments in retirement years and fewer workers to support those retirees).

You can see that Australia fits in both categories. It's a resource producer with high levels of personal and corporate debt. We reckon that over the coming years, government debt will grow too.

But Australia will be a target for international investment, given its resource wealth and comparatively high interest rates. That means the country shouldn't have a huge amount of difficulty financing Kevin Rudd's deficits. That doesn't make said deficits are a good thing. And it doesn't mean Aussie interest rates won't rise too, making borrowing more expensive for Aussie businesses and households. But an auction for American bonds is more likely to fail than an auction for Aussie bonds.

Aussie deficits are still wrong-headed and unnecessary, mind you. This recession (and it IS a recession, despite the statistical flim-flammery) was not caused by insufficient consumer and business demand, as Wayne Swan and others stupidly repeat. That's what all the Keynesians say. Thus, their policy prescription is for the government to run a deficit and support spending until consumers and businesses get back on their feet.

But when you diagnose the problem incorrectly, your cure will be faulty too. This is a balance sheet recession. The cause of it was the accumulation of too much leverage at the household and business level. The only cure for this kind of a recession is the write down in non-productive investment made with credit (residential housing, for example) and deleveraging (paying down of debt).

A recession that was caused by too much credit and massive bad investment is not cured by more government spending. It's like trying to cure a cold by kicking a dog. What's more, when you have over-capacity in global industrial production, lowering interest rates to try and stimulate the demand you think is missing is a waste of time. Business won't borrow at lower rates when they don't need to. Why expand production when there is already too much to begin with and demand is stagnant in most places and falling in the rest?

Besides, what does a government really accomplish when it manages to increase consumption through transfer payments? In most of the Western world, increased consumer spending primarily benefits the producers of consumer goods. Those producers are in China and the developing world, not America and Australia. It's true that local retailers may profit. But the bulk of the profits go back overseas anyway.

At the heart of this bad policy is a simple mistake (or simple economic illiteracy). This mistake is thinking that prosperity comes from consumption. Spending money doesn't create wealth. Prosperity begins with capital formation and production. You have to make something you can sell in order to earn an income you can trade for other goods. If you don't make anything, you can't consume.

For some reason, most modern policy makers have it all backward. They think wealth begins with consumption and spending. And in the meantime, they have-along with an assist from the financial industry-engineered a structural change in Western economies that favours the financial industry (which doesn't produce anything) over manufacturing or real goods production.

That's turning out to be a world historical mistake of the first order. But at least for Australia's sake, the consequences of that economic strategy will be somewhat beneficial. As America produces less and borrows more, the buyers of its bonds and dollars will defect to better investments in other places.

Australia is one of those places. So is gold. So is oil. Housing? Not so much. Government bonds? Definitely not. And common stocks? More on those tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Finding Assets that Out Run Inflation as Bond Yields Move Up
• U.S. Bond Prices Rose and Yields Fell
• Lower Bond Yields by Any Means Necessary
• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis
• Look out! It’s The Bond Vigilantes!

"Budget to grab $800m from super funds... After the initial payment in June, super funds will be required to hand over their obligations from temporary residents twice a year, in April and October."

The super balances in question belong to people that have come to Australia, worked for a period of time, paid taxes, received superannuation contributions from their employer, and then left the country to return home.

But stealing private property doesn't seem to worry the government or Kevin Rudd, at least not yet. Besides, as the AFR reports, if these foreign workers want their property back: "Members will be able to claim their savings from the ATO, but from this month former temporary residents will have to pay withholding tax of up to 45 per cent, up from 40 per cent previously."

You see, the process of expropriating this private property is that it will be treated as tax revenue. The Australian Taxation Office (ATO) will tax these super balances at 100%. The funds will then be added to the government's consolidated revenue - in other words, straight into the government wallet for it to spend.

It all sounds very Venezuelan doesn't it? Kevin Rudd and superannuation. Hugo Chavez and oil.

Needless to say, not only is the Rudd government grabbing $800 million from superannuation, but because it will spend the money to 'save' the economy, it will add another liability to Australia's balance sheet as each year more money is snaffled from savers and spent.

And the scary thing is, I saw this coming. I wrote in Money Morning recently that now would be the perfect time for the government to sink its paws even further into your wallet and your savings. But even this has happened quicker than I thought possible.

Is Kevin Rudd coming for YOUR retirement cash?

The next logical step is for the government to grab the superannuation balances of all working Australians. Don't forget, the government is about to embark on a massive $200 billion spending spree and it's got to pay for it somehow.

Australian taxes are already high. What are the other options? It can increase the GST for starters, but that's only going to drip feed through to government coffers. If it wants a big one-off hit what better way than to get hold of the $1 trillion held in superannuation.

It would wipe out government debt in an instant and still leave it with plenty of your money to spend on wasteful infrastructure projects.

What this means is that yet again savers are being punished. The dream of paying for your retirement with your super could be about to end. To read more about how developments in the market affect your super, make sure to sign up for my free daily e-letter Money Morning. Click here to sign up to Money Morning.

Kris Sayce
Editor, Money Morning

• A Look at Debt and Super
• Your Average Australian Super Fund
• World of Super Collides With World of Credit Crunch
• Self Managed Superannuation Funds on the Rise
• Your Actively Managed Superannuation Fund Cannot Beat the Market

Notice they didn't rob a bank, at least not in the conventional sense. Besides, there's no point in robbing a normal bank if the government is going to systematically ruin the money anyway.

Speaking of gold, the U.S. gold price jumped up $14.10 to trade back over $900 again. It was the first time old yeller metal has traded there in three weeks. The World Gold Council reported that inflows of gold into exchange traded funds were 456 tonnes for the first quarter of the year. That compared to 321 tonnes for all of last year.

ETF demand for gold is definitely one of the short-term drivers of the gold price. Gold is far more investable to retail and institutional investors than it was five years ago. Of course owning shares in a gold ETF is not the same thing as owning gold bullion or gold coins. But as a driver of the gold price, there's no doubt investment demand is a big contributing factor.

Of course the big question for Aussie investors is what the Aussie gold price is doing. It bounced of $1,200 on April 17th and is up about $60 since then. That's down from the 52-week high above $1,500. But the question we hear most often is what happens to the Aussie gold price if the U.S. dollar weakens and the Aussie dollar strengthens?

The simplest argument we can make is that the Aussie gold price is going to be driven primarily by the bull market in gold and not weakness in the Aussie dollar. It can get confusing. But the thing to remember-whether you agree with it or not is another question-is that we're forecasting competitive devaluations in global currencies. This is bullish for gold in any currency.

Here in Australia, it's true the government has a good credit rating and that it's begun its borrowing binge from a position of relative fiscal strength. But we have a hard time imagining that recurring fiscal deficits and more stimulus plans are bullish for the Aussie dollar.

What would be bullish for the Aussie dollar-and thus negative for the Aussie gold price-is a rebound in the Aussie economy or a big increase in Aussie interest rates that attracted foreign capital back to Australia. We don't expect either of those things to happen, given how stingy capital flows seem to be getting. But if either of both happened, it would cap the rise in gold in Aussie dollar terms.

Mostly we would tell readers that the month to month variations in the gold price have no real bearing on our long-term forecast. If you think the current financial system is a lot less stable than it appears, you should have some portion of your assets in gold bullions or coins. Gold shares give you leverage on the rising gold price.

Mind you, gold is not a fail-safe investment. The deflationists argue that the collapse of the credit bubble cannot be prevented by fiscal stimulus or monetary excess. The argue that as trillions in credit and phony money drain from the global economy, all asset prices (including gold) will fall lower. They could be right.

As we've said time and again, the time-tested preferences for governments is to inflate their way out of debts. This has always been for gold. It will be again. But remember, gold is a way to store and preserve your wealth until you can convert into something that's an actual medium of exchange.

It's possible, of course, that people will begin using gold and silver as a medium of exchange for large transactions. But for smaller ones? Who knows? In post-Soviet Russia, vodka and petrol became a kind of currency. You could barter with them to get what you needed.

The point is that what people have used as a day-to-day medium of exchange has changed all over the world over time, depending on the benefits of that medium (liquid, stable, convenient, storable, non-counterfeitable.) What's also true is that ownership of physical gold has been one way to store a portion of your abstract wealth in tangible form until you convert it into something else or trade for goods and services.

If you think it's crazy or impossible we'll ever get to a world where people have more confidence in the gold in their safe instead of money in the bank, fair enough. But just remember, this whole experiment with fiat money is not even one hundred years old. Just because it's all we're used to doesn't negate that for 5,000 years of human history, people have been using gold as money.

Are you ready for today's instalment of tortured English? Good. Here we go! The Prime Minister (Kevin Rudd) said yesterday , "The first home owner's boost, as you know, we have indicated that will conclude within a very fixed and finite time frame...It's had strong, useful results so far, but I have got to say all good things must come to an end."

Can time frames ever be anything but finite?

In any event, the Prime Minister didn't exactly, in a fixed and finite way, say that the FHB grant would be extended beyond its June 30th expiration date. If you were the suspicious or sceptical sort, you might think the PM is doing his best to "bring forward" even more future housing demand now. There's nothing like a vague warning that this deal can't lest to push those young fence sitters out of the rental market and into debt.

Or maybe the PM is having night terrors about a whole new generation of "homeowners" who lose their jobs and then lose their homes as interest rates rise from their historic lows. Then he'd have a whole heap of angry voters wondering why they got suckered into the housing market right at the top just so the PM could look like he was doing something to make homes more affordable (when he was really just throwing a bone to the construction and real estate industries and propping up prices for investors.)

How will it all end? A prediction: RuddBank will end up buying these FHB mortgages from the banks over the next few years. The government will directly negotiate mortgage payment moratoriums and foreclosure prevent programs to keep people in houses they simply can't afford at these levels. Just a guess...

How about some reader mail?

--DR.

One topic that is bothering my mind, we always hear about debt and how much each of the country has to borrow to pay for the Stimulus, deficit budget etc., Who is going to lend us (or leave it to the banks to worry about it) ? China may be the only country in the world that has some reserves. Or, are the countries going to print more money and lend it to each other hoping that the future earnings will be able to offset it. When 90% of the countries are in recession, how will this work?

J.

--It won't work well. The creditors will be calling the shots.

--Hi there,

Setting up an online forum for DR Australia readers would result in some excellent content. There isn't a good libertarian forum in Australia that I'm aware of, and judging by the responses to your "send me your plans" request in today's newsletter there are people wanting to be heard, and people who want to hear what they have to say!

Cheers,

David P.

--David, check out www.dailyreckoning.com.au. There is a lively comments section there. We tried a message board last year. It got hammered by Russian spam and porn.

--"You guys would have some credibility if DR wasn't also a well designed sales channel.

Does it ever even occur to you that you could be wrong, like completely? I've read as much as I can assimilate and I see your point of view but I can also see ways that this (GFC) can be changed. I suspect you have a vested interest in this not being the case.

Can you live with being wrong because you, in part, have the 'wrong' motivations?

Bevan H.

--The 'wrong motivations?' Please explain. It sounds like you're suggesting we have a secret agenda that is uniquely designed to profit from global financial apocalypse, and are speeding the world along to that very result with our daily missives.

Sorry to disappoint you, but we have not used subscription revenue from out two newsletters to build a bomb-shelter here at the Old Hat Factory and stockpile it with jars of canned green beans and powdered milk. And really, if you are sceptical of our motives, then our four hours of daily work is probably not worth your time.

But for the record, we'll explain exactly what our motivations are...we're in business to make money. We do that by writing free daily e-mails here (this and Money Morning) in which present our best ideas each day and give you a viewpoint on the markets that you don't get elsewhere. If you like it and the ideas good or valuable, we hope that at some point you'll buy one of our investment newsletters in which we lay out the actual strategies and share tips we think will work if we're right about the market.

Of course we could be wrong. It's happened before. It's going to happen again. But we're not cheer-leading for a collapse in the global economy because it would be good for the gold shares we've tipped in Diggers and Drillers or good for our business. Exactly how many people do you think would be buying financial newsletters if the global economy enters the kind of Depression we've been talking about?

It always amazes me when people question our motives. Of course we're in business to make money. We'd be stupid otherwise. But at least in this business, our interests are completely aligned with yours. It's completely transparent. You read the free e-letter. If you find something valuable, you buy the newsletter. If the tips do well and you like the ideas, you keep it. If not, you don't.

There are no management fees or transaction fees. We're completely at the mercy of subscription income revenue, which means we're completely accountable to our customers (not shareholders or advertisers). This is just the way we like it, of course. It gives us the freedom to publish analysis and criticism or investment ideas that we could never publish working for a mainstream paper or and stock broker.

That's what's great about this relationship. We get to do what we love full time, which is find investment ideas and analyse financial markets. And if you benefit from that work, then we both make money (or these days, avoid losing it). Our only vested interest is making sure that we do what we say we're going to do each day: tell you what we think and why we think it, even if you think it's crazy!

Dan Denning
for The Daily Reckoning Australia

• Reader Mail: Is the DR Contradictory? Are We Hustlers?
• Aussie Dollar Ready to Storm Past US Dollar
• Gold is the Oldest Form of Wealth
• Aussie Gold Price Moves Up
• AUD Price of Gold a Measure of Gold’s Strength Against Other Currencies

You get the sense that investors are of two minds, both probably subconscious. On the left shoulder, a little devil whispers into their ear that there is still at least another US$1 trillion in losses to be taken by the global financial sector. It warns that asset deflation can last for years and resist quantitative easing.

"Look at Japan puny human. Its exports fell 50% year-over-year in February. GDP is shrinking at an annualised pace of 12.1%. Global demand for Japanese goods has collapsed. And it's not just the exporters. It's the consumers too. European and American Banks will need more capital. There will be even more bailouts. The economy won't recover this year. Banks can't resume lending and consumers spending until losses have been taken and debts written off. How can stocks rally? This is not the bottom. Not yet."

In the right ear another devil whispers. "Yes yes, asset deflation is a big worry. But inflation. It has to happen. You can't expand the money supply without causing a rise in prices. It will come when the new money is released from banks into the economy. Watch for it. Prepare. The Fed will create trillions more to buy U.S. bonds. The Chinese will stop buying them. The dollar will crash. Sometime in 2010 prices will begin to soar."

Which devil is right? The devil warning of more asset deflation or the one who has studied monetary history and concludes it has to be inflation? More on that in a moment.

U.S markets dithered with the data on Wednesday. Stocks weren't the story. Bonds were. The bond market tells all. And what's it telling you? Lenders to the U.S. government are demanding higher yields.

The Federal Reserve bought $7.5 billion in U.S. Treasuries. But yields on U.S. ten-year notes rose anyway. Recall that when the Fed announced its plan to begin buying U.S. debt, ten-year yields fell 47 basis points. Since then, though, they've risen by 24 points in five days.

What does that mean? Well, the U.S. Treasury auctioned $34 billion in five-year notes today. Tomorrow, it auctions another $24 billion in lucky seven-year notes. For the whole week, the U.S. is hawking a whopping $98 billion in new debt to finance its old and new spending.

If you're scoring at home, that's a lot of new supply coming on to the market. Just as in any other market, an increase in supply leads to lower prices. With bonds, lower prices mean higher yields. That's bad news for the U.S. government because higher yields mean higher borrowing costs, and the U.S. government has world-class borrowing plans.

So in steps the Fed to try and cap yields, which also keeps other rates that are pegged to the ten-year low, like mortgage rates. The only problem?

Today's action in the bond market suggests that investors are not going to play along. If the Fed wants to keep yields down, it may have to buy a lot more U.S. bonds than it expected. There may be a lot more sellers than it expected. And a lot fewer buyers.

Take the U.K. Today, for the first time in seven years, the U.K. failed to attract enough bids at an auction of £1.75 billion in 40-year bonds. That's right, investors turned their back on sovereign British debt.

It's not so surprising given the economic situation in the U.K. Britain is again the poor man of Europe (unless you count Iceland, which is really the destitute man of Europe). In Britain, you have crashing house prices, a banking sector in disarray, public finances in an absolute mess, and a Prime Minister who wants to borrow even more money for a bigger stimulus (does this sound familiar?)

By the way, do you get the feeling the G20 meeting in London next week is going to be a circus? Stay tuned on that. Markets may not like it one bit.

The demise of British financial capitalism prompted a British member of the European Parliament to rather publicly take Prime Minister Gordon Brown to the woodshed. It was great! He called him the "devalued Prime Minister of a devalued nation." You can watch the whole thing here. Opposition parties in the U.S. and Australia should take notes.

If you get the feeling that the world's modern financial architecture is buckling, you are not alone. It is. With the U.S. and the U.K. facing massive deficits and Japan joining them in a policy of quantitative easing, basic assumptions about how the world economy works (like whether the dollar is a good long term reserve currency and how much debt a nation can sustain) are being called into question.

Czech Republic Prime Minister Mirek Topolanek hold's the EU's rotating six-month presidency. He used his bully pulpit to cause a diplomatic stir yesterday by saying that the, "The US Treasury secretary [Tim Geithner] talks about permanent action and we, at our spring council, were quite alarmed at that."

There's more. "The US," he said, "is repeating mistakes from the 1930s, such as wide-ranging stimuluses [sic], protectionist tendencies and appeals, the Buy American campaign, and so on...All these steps, their combination and their permanency, are the road to hell."

We reckon our asset deflation devil and our inflation devil would both like that. All roads lead to the same place now apparently. And it isn't Rome.

Meanwhile, back in Australia, regulators and politicians face a moment of truth about Australia's economic future and how much if it is going to be determined by Australians. The Australian Competition and Consumer Commission (ACCC) has ruled in favour of Chinalco's $28 billion bid for Rio Tinto. Now all that's left is for the Foreign Investment Review Board (FIRB) and Treasurer Wayne Swan to sign off on the deal.

But according to today's Australian, the ACCC ruling was based on an assumption the commission made. That assumption is that the Chinese government is the ultimate bidder for Aussie assets and that Chinese companies are all subsidiaries of the government.

This leaves the door open for Kevin Rudd to make a deal with his friends in Beijing in the style of Thomas Jefferson's Louisiana Purchase. We'll get to that in a second. But before we do, can someone please explain Australia's policy with respect to investment from Chinese state owned enterprises? The clock is ticking...

The FIRB has three bids in front of it at the moment and it's neither approved nor denied any of them. Hunan Valin Iron and Steel Group wants to buy 17.6% stake in Fortescue Metals (ASX:FMG) for $644.8 million. Fortescue wants to sell. The FIRB wants another thirty days from March 25th to think things over. Meanwhile, Macquarie Group says Fortescue faces a $731 million shortfall to fund its expansion plans.

Next, China Minmetals has made a $2.6 billion bid for distressed miner OZ Minerals (ASX:OZL). But on Tuesday shares of OZL (already in the pits, much to our chagrin) fell as much as 15% when the FIRB announced it was delaying its decision on the Minmetals bid by another 90 days. OZ has $1.3 billion in debt and desperately needs more capital before March 31st.

So now the FIRB must deal with Chinalco's bid too. Will it delay that decision too? On March 18th, the Senate Standing Committee on Economics began a Parliamentary inquiry into foreign investments by state owned entities. It's reviewing how to deal with Chinese Investment. You could also call it stalling.

The trouble is, the inquiry isn't scheduled to report back to the Parliament until June 17th. The FIRB has knocked back the OZ-Minmetals ruling until June 22nd. And it's knocked back the FMG-Hunan ruling until June 14th.

What will the FIRB know by the second week of June that it does not know now? Further, how can it be so sure that credit markets will roll over Oz's debt, or that Rio's share price won't again decline as investors worry about how it's going to finance the massive debt it used to finance the Alcan acquisition?

Markets are moving pretty fast these days. June is a long way away. And here's the important point: Australian firms need capital badly.

The government seems happy to give money away to people who want to drink, buy TVs, and gamble. And it's happy to subsidise commercial property development (because falling property prices would be a national and electoral disaster). But it seems like it's doing everything it can to make life miserable for the miners who make up such a large part of the national economy.

But the Chinese are here to help. They have trillions of U.S. dollars. They would like to get rid of them. A trade of dollars for tangible assets is in order. So shouldn't a deal be made?

After all, let's be candid. Even though there is a lot of engineering and expertise required to be a world-class low-cost commodity producer or miner, extractive industries are low on the value-added chain in economic terms. The raw materials command a certain price. But the finished consumer and manufacturing goods they are turned into command a higher price with a larger profit margin for the manufacturer or the ultimate retailer.

If Australia is trying to figure out how to maximise the value of its natural resources, certain facts about the economy should be put on the table. It's a two tier economy. On one tier you have the banks and the finance sector. On the other you have the resource industry.

We all know it's a bear market in credit. The Aussie banks may or may not suffer more losses on their loan books. But the era of finance as a generator of outsize profits for shareholders is probably well and truly over for awhile. You can't build a national economy on banking (unless you're Switzerland, which cops it for being a tax haven).

That leaves the Aussie economy with resources. It has a willing long-term partner in China. And there's no doubt China will be Australia's principal resource customer for decades to come.

The Parliament, then, has to make a deal or craft a policy that maximise the value Australia gets for its resources. And it has to do so acknowledging that Chinese capital is critical to the development and expansion of the industry as a whole.

So here is our plan: sell China a 50-year lease to Australian resource projects. Demand an annual royalty or excise tax. Distribute the profits from the lease sale to regular Aussies. Presto!

No more need for government borrowing. Nor more stimulus plans. No more hand wringing. Just make a deal with your inevitable partner and guarantee the national cash flow for years. You can even call WA "New South Shanghai."

It might not be popular at first. But just do the maths. Let's say the price of the 50-year lease is US$1 trillion, or about A$1.43 trillion. You might even raise the price, to account for inflation. But even if you leave it at $1.43 trillion that amounts to around $28.6 billion a year for the next fifty years.

You could, if you liked, simply cut everyone in the country a check for $1,361 each year. It would be the Chinese Dividend. Imagine how much stimulating it would do!

There are problems, of course. A mere $28.6 billion a year is admittedly less than the current total value of Australian resource exports. So the lease price might have to be raised. But it's a beginning...

Of course we're joking. But we are serious about one point. The Chinese have capital and need Australia's resources. Australian firms have debt and need capital. It's a global bear market in credit. Australia and China are destined to be long term partners. The Prime Minister speaks Mandarin. Will it really take until June 17th to figure out how this is going to end?

Lots of reader mail on housing came in. So much so, in fact, that we'll deal with it in a special essay tomorrow. Until then, here's some reader mail.

Dear Dan,

You wrote, ""This alleged shortage is often alluded to but never proven..."

Rising rents are proof.

Guy B.

Dear Dan,

Regarding the housing shortage, I own a block of 12 units. About 5 or 6 years ago when a tenant vacated the unit, it would take several weeks to re let the unit. These days when a unit is vacated it is filled within a few days.

We may not have a chronic housing shortage to the point where people are sleeping in their cars, but I do think we have one. And if you are wondering why aren't developers developing than consider this (1) construction costs are still very high compared to resale value, thanks to a lack of competition is steel, concrete, copper piping, copper wiring and other material pricing (2) the GST is a killer for developers, if the govt is serious about getting the construction industry going all they have to do is get rid of the GST and it will boom (3) to a lesser extent bank financing, but the reason this is an issue is because 1 and 2 make most projects barely viable.

Regards,

Michael

Dan,

You write "The number of first home buyer commitments as a percentage of total owner occupied housing finance commitments increased from 25.7% in December 2008 to 26.5% in January 2009. This is the highest level recorded since the series commenced in 1991" - but you omit to state what the annual levels or average level has been since 1991.

If it has always been around the 20-30% mark then it would look like you are sensationalising. If however the figure has risen substantially in recent years from a much lower average then that would be something.
For the record, the AFG mortgage survey we cited yesterday showed that first home buyers accounted for just 12.1% of new mortgages in January of 2008 compared to 26.1% in February of 2009. That's an increase of 115%, and very subprime-esque in our view.

But the Reserve Bank provides a little clarity on this matte too. The RBA's Head of Economic Analysis, Anthony Richards, gave a speech yesterday about Australian housing in which he said, "First-home buyer demand is also expanding following the boost to grants for these buyers. We can see this from the increase in the number of grant payments made in recent months and the rise in the share of first-home buyers in loan approvals to the highest on record."

He also provided this handy little chart. More on his report and housing in the essay section tomorrow.

First Home Buyers Surge Into Housing

Source: Reserve Bank of Australia

Hi Ho Dan,

Love you site, great direct no bull info. I have one nagging question that has been testing my "grey matter" for months.

Let's say 20% of the Milky Bar Kid's "working families" lose their bread winner. We still have 80% of the "working serfs" paying their 9% into super funds. That is a huge lot of paper that must go somewhere safe.

Will the keepers of the cash invest locally in mortgages? Will the Banks soak this up in place of imported funds?

Regards,

Ian H.

Good questions. The banks could fund local lending from local deposits. The question is whether Super fund managers risk putting Super contributions in cash rather than shares or mortgage and property funds (not guaranteed by the government). After all, who wants to pay a Super fund manager to put you in cash? You do that yourself in a self managed fund.

Hi Dan,

The giant ponzi scheme is really heating up with that news from the Fed. Perhaps we could call it a Fonzi scheme?

So Freddie and Fannie, who are essentially bankrupt, are raising debt capital from the Fed. This is used to make new loans, which are then securitised and sold into the open market, trading as agency MBS.

Actual market players are no longer keen to buy these at low interest rates, so the Fed has to step in as the marginal buyer to affect the price. The Fed prints money to buy agency debt and prints money to buy the securitised asset...itself the product of the debt it created out of thin air.

Then I read some clown who says, 'this action will help everybody, maybe the Fed can put humpty dumpty back together again'. The animals are now well in charge of the zoo. This is not going to turn out well.

G.
Probably not.

Dan Denning
for The Daily Reckoning Australia

• Australia’s Capital Crisis and its Chinese Future
• Speculators and Chinese Firms Accumulating Australian Resource Companies and Commodities
• The Iron Ore Pricing War Between China & Australia
• Arable Farmland More Precious Than Gold
• One Year Treasury Bills to be Reissued by Bush Administration

Or maybe not. We'll just have to see. Either way, if Tim Geithner's plan sends the market down five percent or more this week, we reckon it's his last week on the job, which may be a relief to Mr. Geithner.

Kevin Rudd conceded that Australia's economic fate is largely tied to forces beyond its control. In an interview with Channel Nine over the weekend he said, "A worsening global economic recession will make it virtually impossible for Australia to sustain a positive economic growth for the period ahead, with impacts, of course, for budget and employment."

Of course. That means, by the way, February's unemployment rate of 5.2% (the highest in four years) is probably headed higher. Not having worked in the private sector recently (or ever?) the Prime Minister may be underestimating how many of Australia's businesses are prepared to shed jobs amidst uncertainty. "More than half of Australia's mining and resource companies will fire staff in the next 12 months," Bloomberg reports.

The "budget impact" will be a higher government deficit. True, it won't be as bad as the A$13 trillion U.S. deficit over the next ten years. That's what the Congressional Budget Office is projecting if Barack Obama's spending plans go through Congress unchecked. It's massive.

But a deficit is a deficit. The money has to be borrowed from someone. And it has to be paid back later, through higher taxes or more borrowing (not to mention the interest). It's not a good habit to get into, living above your means because you are unwilling to cut back on your lifestyle.

In any event, the big news this week will be how markets receive U.S. Treasury Secretary Tim Geithner's toxic asset plan. By all accounts, it sounds like Geithner wil make US$1 trillion (or thereabouts) available to hedge funds and private investors in order to buy aforesaid toxic assets from America's banks.

"Here. Take this $1 trillion. Buy those bad assets. Benefit from the upside. We'll take all the risk...What's that? Why yes, of course I'm serious."

If you've been paying attention to the way the U.S. Congress treated AIG executives during hearings last week, you'll wonder why anyone of sound mind would want to become a business partner of the United States government. It's a government that is now willing to change the laws to punish people of whom it disapproves. And before that, it's a Congress that was willing to pass a thousand page stimulus package that no one had read.

Does anyone really believe these idiots have any idea what they're doing? And does anyone believe private capital will hold hands with Uncle Sam and take his borrowed money to buy toxic assets?

On the face of it, using someone else's money to take risk doesn't seem so bad. But given the last few weeks in Washington, private investors would have serious doubts about whether any profits that might result from owning those assets would actually go to investors, or would be confiscated by the Congress. "Political risk" is the kind of investment risk you used to associate with dictatorial regimes in Africa, not democratic regimes on the Potomac. But there's no doubt investors in America (like China and its US$700 billion in bonds) now face real political risk.

All of which is to say that the government is making investors more nervous and more risk averse. This is not the kind of indifference that comes with bottoms. This is the kind of panic that comes with crashes. There's a chance that could change that week if the Geithner plan is well received and the morons in Congress put down their pitchforks. But if it doesn't change for the better, it could change for the worse.

And even assuming the plan is well received, banks are still going to need more capital before they begin lending again. Former Fed Chairman Alan Greenspan told investors at a conference in Acapulco Mexico that, "Restoration of normal bank lending will require a very large capital infusion from private or public sources."

He puts this number somewhere "north" of US$750 billion.

A trillion here. A trillion there. Pretty soon you're talking about a bankrupt America.

What all this means for Australia is still not quite clear. Australian banks are still lending for new mortgages and they don't, on the surface anyway, appear to be having any trouble borrowing money themselves. We're keeping an eye on both (lending and borrowing by the Big Four).

The huge American deficits make the U.S. dollar weak. The Aussie has been rising, as have gold and oil. Greenback weakness is commodity bullish (not across the board though). And Australia is not one of those countries that has pegged its interest rates to U.S. rates. That means Australia does not have to match U.S. rate cuts to keep its currency pegged (as is the case in some of the Gulf States, China, and other places).

So the good news is that Australia does not necessarily have to import inflation from the U.S. The bad news is that economic conditions are getting worse, not better, meaning that inflation might get to these shores anyway. If unemployment rises, stocks stay flat, and trade weakens, it wouldn't surprise us to bigger government deficits with larger spending plans and more rate cuts. Growth in the money supply is inflation. It shows up later in higher prices.

And for housing? That's what many Aussies treat as "Plan B." It could be that you see a resurgence in house price inflation as Aussies turn away from the share market in favour of the myth of perpetually rising house prices. Although it may look appealing for awhile, it may not end well.

Two or three years down the track-maybe sooner if unemployment grows faster-we can see the Reserve Bank in the position of having to raise rates to contain inflation. It will have done so after hundreds of thousands of younger, marginal buyers have been sucked into the housing market with First Home Buyer grants. How will they cope with rising rates? How will they cope with falling prices? How will they cope with losing their jobs?

"Australia has certainly been a levered play on this global commodity boom and if we truly had been in a super-cycle, then it was a brilliant move," Stephen Roach of Morgan Stanley says. "But the global commodity boom has also gone bust, and this has caught Australia without much in the way of a diversification or a backup plan."

More on how to actually diversify tomorrow.

Dan Denning
for The Daily Reckoning Australia

• The Geithner Plan
• Australia’s Response to the U.S. Bailout Plan
• America’s Debt Woes
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way

It isn't a four-letter word uttered by Prime Minister Kevin Rudd on TV at the weekend that continues to get everyone in a tizz. Instead it's four-little-words that everyone is rushing to embrace. Words that define the resurgence of a failed and discredited economic theory.

Those four little words are... The Paradox of Thrift.

Even more of a paradox is that the man who first uttered the phrase, the 1st Baron Keynes (or John Maynard Keynes to you and me) would have gone to his grave in 1946 believing he had created an economic theory to outlive all other economic theories.

Therefore if technology and science would allow it, if we could bring him back to life sixty-three years later, he would not be surprised that economists, journalists and commentators are embracing his ideas.

But not only are they embracing the ideas, they are putting them into practice.

And unfortunately, each idea leads us down the same path. It is the path towards rampant inflation. Many times in recent months I have written to Money Morning subscribers about the threat of inflation (you can read some of those thoughts in the essay below). Each time we write about it we think "That's all there is to write about, policy makers couldn't possibly make things worse."

Then we open the newspaper, switch on the TV or read news stories on the internet. Soon enough we realise our imagination is incapable of matching the ideas put forward by the mainstream press, mainstream finance professionals and policymakers.

A perfect example was a quote we read in yesterday's Australian Financial Review (AFR). When you read the quote it is important to remember that this isn't the thought process of one isolated member of the finance industry. It is the thought process of 98.6% of those in the industry, and the thought process of 100% of those that advise our politicians.

The quote was from Adam Carr, senior economist at ICAP Australia:

"I think when you print money, it becomes very attractive [for investors] to take advantage of the fact that money is just given away for nothing."

Remember, Mr. Carr isn't an 'outlier' he is the mainstream. It really does drive home the point that when you read in the Daily Reckoning the possibility of Weimar Republic or Zimbabwe style hyper-inflation it isn't just to get your attention. It is because policy makers are actually pushing ahead with policies that are taking Australia a step closer to it becoming reality.

It is Keyne's 'Paradox of Thrift' that commentators are now paying close attention to. Why? Because unlike inflation and money supply, the 'Paradox of Thrift' can be easily understood and explained by the mainstream. For them, it is a simple equation...

The economy isn't growing because consumers aren't spending. If consumers aren't spending they must be saving. If consumers are saving that is why the economy isn't growing... Therefore saving is bad, spending is good, the economy must grow and the 'Paradox of Thrift' must be correct.

How can you argue with logic like that? Fortunately we can, and we do.

[Ed note: That's why you need to do your part and let as many of your friends, acquaintances and colleagues know about The Daily Reckoning (and Money Morning) so they too can read why government spending and the RBA giving away money "for nothing" is such a bad idea for Australia.]

But that's only part of it. Because inducing the consumer to spend by cutting interest rates to artificially low levels still isn't working. So how can government cut out the middle man? They can do exactly as Mr. Carr suggests, they can print money and give it away for free.

Obviously there's no point in giving it away to the newly frugal ex-consumer. Nosiree, because the ex-consumer had morphed into a saver. And printing money to buy government or corporate debt isn't likely to work either, because those are mainly held by fund managers. They'll just take advantage of the high prices being paid by the central bank by selling to them and then just buying the same or similar bonds again in the market when prices have softened.

Nope, there's only one solution to make sure the 'free money' goes to those who truly know what to do with it. And that's to give it to federal, state and local governments. You must have seen how quick they were to reveal all of their "shovel-ready" projects. "Just pay us the cash and we can start these projects straightaway" was the universal cry.

As we mention below in today's essay, the ultimate losers will be those that the government claims it is trying to help - individuals (families) and business.

The individuals will lose out, because as consumers they will be burdened by the combination of the devaluation of their earnings and savings, and the increase in prices. And small businesses in particular will be denied the chance to take market share from companies that would have otherwise failed.

As with many things, there is a bright spot. That is, government is notoriously bad at doing things. Therefore, the paradox they may not have bargained for is one based on their inflationary policies failing. The possibility is that what exists of a free market in Australia will be strong enough to ensure that individuals and small companies are agile enough to see through the recession and emerge stronger on the other side.

As for government, its failed policies should result in it becoming weaker and the free market gaining the ascendency.

Cheers.

Kris

The Most Important Money Morning Story This Week: In recent weeks and months you will have read a lot about the importance of government 'stepping in' to save the market. The shouting from the rooftops has become louder following the revelation that jobs could be lost in a recession. So, in Friday's Money Morning we took a simple look at the claims that 'extreme capitalism' had ruined everything for everyone. As it happens, there hasn't been extreme capitalism at all, rather it has been extreme government. Click here for more...

Monday: It is taking a very long bow to suggest that because Australia maintained a 'Four Pillars' banking policy that has somehow saved the local banks from oblivion. In the world of cause and effect 'Four Pillars' is nowhere to be seen. It is a mere coincidence. Click here for more...

Tuesday: So, does this mean that everything is fine in the world of banking? As far as we're concerned, it is still too early to say. Sure, you can buy the shares today on a yield of 10%, but it still can't be guaranteed the bank will maintain the full year dividend. Click here for more...

Wednesday: The problem with well diversified portfolios is that they aren't really well diversified at all. They tend to be diversified in the same direction. A managed fund split between Australian shares, international shares, property, bonds and cash isn't diversification at all. Click here for more...

Thursday: However, as we mentioned yesterday, there is still too much uncertainty surrounding the banks and their profitability for them to be considered the reliable investments that they were a few years ago. Click here for more...

Friday: With six and a half billion people in the world, the demand for energy has never been greater. This demand - especially from China and India - is the hidden engine behind Australia's economy. One Perth based company is perfectly poised to capitalize on the voracious demand for energy. The "energy metal" they mine is critical for sustained renewable energy. Click here for more...

• The Path Towards Rampant Inflation
• Gold, Commodities and Markets
• What’s a Consumer Economy Need in Order to Keep Growing?
• Geitner Plan Falls Short
• Real Estate Brokers: The Latest Victims of the Housing Crunch

Those four little words are... The Paradox of Thrift.

Even more of a paradox is that the man who first uttered the phrase, the 1st Baron Keynes (or John Maynard Keynes to you and me) would have gone to his grave in 1946 believing he had created an economic theory to outlive all other economic theories.

Therefore if technology and science would allow it, if we could bring him back to life sixty-three years later, he would not be surprised that economists, journalists and commentators are embracing his ideas.

But not only are they embracing the ideas, they are putting them into practice.

And unfortunately, each idea leads us down the same path. It is the path towards rampant inflation. Many times in recent months I have written to Money Morning subscribers about the threat of inflation (you can read some of those thoughts in the essay below). Each time we write about it we think "That's all there is to write about, policy makers couldn't possibly make things worse."

Then we open the newspaper, switch on the TV or read news stories on the internet. Soon enough we realise our imagination is incapable of matching the ideas put forward by the mainstream press, mainstream finance professionals and policymakers.

A perfect example was a quote we read in yesterday's Australian Financial Review (AFR). When you read the quote it is important to remember that this isn't the thought process of one isolated member of the finance industry. It is the thought process of 98.6% of those in the industry, and the thought process of 100% of those that advise our politicians.

The quote was from Adam Carr, senior economist at ICAP Australia:

"I think when you print money, it becomes very attractive [for investors] to take advantage of the fact that money is just given away for nothing."

Remember, Mr. Carr isn't an 'outlier' he is the mainstream. It really does drive home the point that when you read in the Daily Reckoning the possibility of Weimar Republic or Zimbabwe style hyper-inflation it isn't just to get your attention. It is because policy makers are actually pushing ahead with policies that are taking Australia a step closer to it becoming reality.

It is Keyne's 'Paradox of Thrift' that commentators are now paying close attention to. Why? Because unlike inflation and money supply, the 'Paradox of Thrift' can be easily understood and explained by the mainstream. For them, it is a simple equation...

The economy isn't growing because consumers aren't spending. If consumers aren't spending they must be saving. If consumers are saving that is why the economy isn't growing... Therefore saving is bad, spending is good, the economy must grow and the 'Paradox of Thrift' must be correct.

How can you argue with logic like that? Fortunately we can, and we do.

[Ed note: That's why you need to do your part and let as many of your friends, acquaintances and colleagues know about The Daily Reckoning (and Money Morning) so they too can read why government spending and the RBA giving away money "for nothing" is such a bad idea for Australia.]

But that's only part of it. Because inducing the consumer to spend by cutting interest rates to artificially low levels still isn't working. So how can government cut out the middle man? They can do exactly as Mr. Carr suggests, they can print money and give it away for free.

Obviously there's no point in giving it away to the newly frugal ex-consumer. Nosiree, because the ex-consumer had morphed into a saver. And printing money to buy government or corporate debt isn't likely to work either, because those are mainly held by fund managers. They'll just take advantage of the high prices being paid by the central bank by selling to them and then just buying the same or similar bonds again in the market when prices have softened.

Nope, there's only one solution to make sure the 'free money' goes to those who truly know what to do with it. And that's to give it to federal, state and local governments. You must have seen how quick they were to reveal all of their "shovel-ready" projects. "Just pay us the cash and we can start these projects straightaway" was the universal cry.

As we mention below in today's essay, the ultimate losers will be those that the government claims it is trying to help - individuals (families) and business.

The individuals will lose out, because as consumers they will be burdened by the combination of the devaluation of their earnings and savings, and the increase in prices. And small businesses in particular will be denied the chance to take market share from companies that would have otherwise failed.

As with many things, there is a bright spot. That is, government is notoriously bad at doing things. Therefore, the paradox they may not have bargained for is one based on their inflationary policies failing. The possibility is that what exists of a free market in Australia will be strong enough to ensure that individuals and small companies are agile enough to see through the recession and emerge stronger on the other side.

As for government, its failed policies should result in it becoming weaker and the free market gaining the ascendency.

Kris Sayce
for The Daily Reckoning Australia

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