According to Goldman Sachs, robust 2010 oil demand growth will deplete these inventories over the next 12-to-18 months and diminishing production rates in key areas around the world will create a supply/demand imbalance.

The top portion of the nearby chart shows the decline in production from the world's top 230 projects. After peaking in 2009, production from these projects is set to fall for the next several years. Excluding OPEC countries (bottom portion of the chart), the decline rates will likely quadruple from 2007 to 2012.

Over that time period, non-OPEC production is expected to fall by 2.5 million barrels per day. Only Brazil, Canada and the former countries of the Soviet Union are expected to see production growth.

One of the largest contributing factors for this is chronic decline rates from some of the world's top mature fields. Mexico's Cantarell field, one of the largest oil fields in the world, produced 30 percent less oil in 2008 than it did in 2007 - a trend that's expected to continue.

Norway, the world's 11th largest oil producer in 2008, saw its oil production peak in 2001 and is down 27 percent since. Another big producer, Venezuela's state-owned oil company PdVSA has seen annual decline rates of more than 25 percent in certain fields according to the Energy Information Administration (EIA).

Adding to the dilemma, many countries without decline-rate issues have been holding out production increases until projects become more cost effective; this is why we recently saw Russia overtake Saudi Arabia as the world's largest oil producer.

The Saudis have been content to sit on the sidelines while awaiting the return of higher prices. The same goes for other OPEC countries; PIRA, an oil-industry consultant, says the cost of oil will have to rise above $80 per barrel in order for the cartel to increase production.

With oil prices currently hovering around that $80 level, OPEC officials have recently hinted that production increases aren't off the table for the cartel's upcoming December meeting.

But even if we see a production increase out of OPEC, decline rates from maturing fields and high barriers of entry to bring new fields online should keep the supply/demand balance tight for years to come.

Regards,

Evan Smith and Brian Hicks
for The Daily Reckoning Australia

• No Spike in Oil Price Following IEA “Third Oil Shock” Announcement
• BHP Billiton: The Oil Company That is Not an Oil Company
• Where Will Future Oil Production Come From and How Can Investors Profit Today?
• Oil Price Chart Shows Slight “Correction” in Near Future
• OPEC Agrees Not to Cut Oil Production Until it Meets in May

The team at Casey's Energy Opportunities believe that planned government buying or selling of crude oil for SPRs actually have very little impact in the overall market. However, an overall drawdown of worldwide inventory could put downward pressure on the price of oil. The various countries also have their particular reasons and influences in decisions to tap their reserves.

So which countries are executing preparedness plans to fill their strategic reserves with $70 oil now (as opposed to $140+)? Below are the 10 countries that consume the most oil in the world, as of 2008, the latest figures available from the BP Statistical Review of World Energy:

Russia, Canada, and Saudi Arabia can leave the list, as they are net exporters of oil and thus do not actually require a strategic reserve, at least in the short term. We'll also bump Brazil, because its balance of imports is dwindling every year, and it should become a exporter before it requires a reserve. That leaves six countries to examine:

The United States

Not surprisingly, America has the largest strategic reserve in the world in an absolute sense. Its 727 million barrels are stored in four hollowed-out salt domes (and one pending) along the coastline of the Gulf of Mexico. These add up to some 62 days' worth of imports, according to government sources. The United States government currently has plans to push this to 1 billion barrels, or about 85 days' worth of imports, which would make the reserves equivalent to those of Japan and Korea.

The SPR build-up will be accomplished by expanding two of the current facilities, for an additional 113 million barrels, and (probably) building a new one in Richton, Missouri, for 160 million barrels. The Richton project has met local opposition, because it would require pumping 50 million gallons of freshwater per day from the Pascagoula River to dissolve enough salt to open up another subterranean cavern. The total cost of the program is estimated at US$3.7 billion, not including the cost to fill the reserves. Oil purchases are likely to be slow, at around 100,000 bpd (barrels per day) before 2014 and 150,000 bpd thereafter.

In a real emergency, the combined American strategic and commercial reserves (the latter held by private corporations, especially refiners) may seem unnervingly thin from the perspective of energy security. Add to that the fact that the government can release them at a rate of only 4.4 million barrels per day, or about half its imports.

Still, the 108 or so days' reserve it has between government and commercial sources are considered adequate by international standards. The United States has used this reserve twice in the past 20 years (Desert Storm and Hurricane Katrina) to combat severe demand or supply disruptions. It also has the luxury of importing more oil from Canada in an emergency.

Scenarios that could force a sustained drawdown of reserves:

• Sustained hyperinflation in the United States due to actions by the Federal Reserve that causes oil-producing countries to look for better markets to sell oil.
• A prolonged general embargo by OPEC on the United States, forcing America to look to traditional partners such as Canada and Mexico, though they might not have sufficient oil.
• Another war, potentially in North Korea or Iran, requiring a large amount of oil input from America that it simply does not have.
• A particularly active hurricane season that knocks out a large amount of production capacity in the Gulf of Mexico, and the United States releases from the SPR to help.

China

China's strategic reserves began being built in 2004, when leaders in China began to realize that the country had no adequate government- controlled reserves to combat any disruptions in the supply of oil. China is a large importer and is dependent on the same sources of foreign oil as the United States. China is even more anxious to build such a reserve, as two of its neighbors, Korea and Japan, both have large strategic reserves.

China currently has four government reserves with a total reserve potential of 272 million barrels, which translates to about 30 days' consumption. Two of the four have been confirmed full, and there are rumors that all four are and that China has taken advantage of the recent precipitous drop in the price of oil to buy up. According to Chinese government sources, however, the reserves are likely not to be completely full until 2010, and 2009 buying of oil will be at around 42 million barrels.

The government has also announced plans to increase the country's reserve from 30 to 100 days of consumption. The next stage of the development will call for an additional 170 million barrels in eight storage facilities. The locations of the facilities are as yet secret.

In an emergency, China would likely turn to Russia to buy oil, though only the naive would be surprised if Russia added a premium for the privilege.

Scenarios that could force a sustained drawdown of reserves in China:

• Worldwide embargo on China due to a Chinese invasion of Taiwan.
• High oil prices force Chinese industries out of business, pressuring the government to keep oil prices low domestically by selling some of the reserves to domestic companies.
• North Korea asks for oil from China to support military action on the Korean Peninsula, and China ships it to them on the black market.
• Russia slows or stops its exports as part of the Russian "dominance via energy" strategy, leaving Chinese pipelines trickling and Chinese industries disrupted.

Japan/South Korea

We have placed Japan and South Korea's reserves together, as the two countries have a treaty that allows them to share their strategic reserves.

Resource-poor Japan has one of the world's largest strategic oil reserves, enough for 82 days of imports. State-controlled reserves are run by the state-owned Japan Oil, Gas, and Metals National Corporation. The reserves consist of 320 million barrels in 10 different locations, which makes them second only to the United States in absolute volume. Japan's island geography means that having an emergency supply of crude oil is crucial, and the Japanese government obviously has not ignored this aspect.

South Korea is in one of the global "hotspots" in the world, right beside North Korea. As the country is under an almost constant threat of war, the government has stocked up some 76 million barrels, with capacity for an additional 40 million barrels.

Scenarios that could force a drawdown of reserves:

• Just one at this time, from two possible sources: political instability in the region caused by either the Taiwan or the Korea conundrums disrupts tanker transport, perhaps even forces them to port.

India

India has a small reserve it began to build in 2004. This stockpile is sufficient for perhaps only two weeks of consumption. The country eventually wants to raise this level to 45 days, though the first phase has not even been completed yet. The projects are estimated to come online in 2012, which means it has taken eight years from planning to completion. These figures imply that India will not even have a somewhat sufficient strategic reserve until 2016, given that the expansion project was approved in 2008.

Germany

Germany has the largest reserve in Europe and is among the top in the world as well. Its government has satisfied a federal law that regulates storage be at least 90 days' worth of net imports. More than half of the storage is in Southern Germany, where large salt caverns exist. Germany is well prepared in its strategic oil reserves, and there are no glaring factors that would force a drawdown of reserves, barring a global catastrophe. Furthermore, the reserves of Germany, France, and Italy are pooled and can be used by any of the three countries in an emergency.

So How Much Do the Reserves Matter?

According to the US Energy Information Administration (EIA) estimates, some 2 billion barrels are held in government-owned strategic reserves around the world. Though this seems like plenty of oil, does it really impact the spot price of oil? Collectively, the answer is yes, as this volume corresponds to 23 days' worth of global consumption. If drawn down together over a short period of time, the effect on spot price could be substantial.

For illustration's sake, suppose that countries collectively draw down their entire reserves over the period of a year. This rate would make up for 10% of the daily worldwide trade of crude oil, which could certainly impact price (imagine ConocoPhillips and ExxonMobil both going under at the same time).

Individually, however, even China and the United States have a limited impact on the spot price of oil over a single year. If the United States' inventory were drawn over an entire year, it would only make for a 4% increase in supply. Under normal buying patterns of each country's strategic reserves, the impact is even smaller. Since China's 42-million-barrel purchase is over one year, their purchase would not even make a dent in the daily trade of oil.

Thus, a concerted effort by the worldwide reserves can definitely keep prices down in the short term (within a year, two at best), but cannot make for a paradigm shift in the supply/demand model of oil or the Peak Oil argument. And from the buying side, if governments plan the filling of their strategic reserves, the impact on the spot price of oil is likely to be minimal.

Perception is a tricky horse to ride, however, as we all know. Given a worldwide panic for oil à la the 1973 oil embargo, oil prices could spike in the short term, because government reserves would likely raise purchases 10% or so in a real emergency. This effect would be short lived for the foreseeable future, though, as worldwide reserves are already reaching their limits.

In short, if everything goes according to "plan" by the governments, even filling a large reserve such as the Chinese SPR would have little impact on the price of oil. For SPRs to truly impact the spot price of oil, it would have to be a global situation, with war and embargo the two most likely scenarios. Even then, the impact would be mellowed by limitations on how quickly governments can either release or purchase the oil.

Regards,

Marin Katusa
for The Daily Reckoning Australia

• How to Buy Crude Oil for US$2 a Barrel
• The War for Oil Reserves
• OPEC Agrees Not to Cut Oil Production Until it Meets in May
• Oil Prices Has The Mogambo Guru Sticking His Thumb in His Eye
• Pemex and Mexican Peak Oil Equal Expensive Oil

Meanwhile, the U.S. dollar index is showing all sorts of weakness. The chart below tells you a couple of things. First, you can see that when the short-term moving averages cross the longer-term moving averages, it usually signals a move. We're not making this up, by the way. We asked technician Gabriel Andre why the crossing of the 50-day MA over the 200-day MA was significant. His answer below.

"Is it sort of like Ghostbusters, where you're not supposed to cross the stream," we asked?

"No."

"Okay, please explain."

"Yes. The shorter-term price action has more weight. When the 50-day crosses the 200-day on the upside, it's bullish, as your chart shows. Conversely, when it crosses the 200-day in a negative direction, as your chart also shows."

"What happens when the longer-term moving average moves down too?"

"When it rolls over?"

"Is that what it's doing?"

"Perhaps. You would have to look at a longer-term chart. But this one indicates dollar weakness, which is showing up in Aussie dollar strength and a rise across the commodity sector. The prices are all relative to the weaker dollar."

Ah yes, the world of relative pricing. We admit we approach the technical explanations of market movements with a great deal of trepidation. The belief among the chartists and the technicians is that all the relevant information about an asset - it's past, present, and future - show up in the chart. You just have to learn how to read the chart, which is admittedly more of an art than a science (in our opinion).

Nonetheless, the chart of the dollar index is consistent with our own fundamental diagnosis of the dollar's weakness. Big fiscal deficits, massive unfunded social liabilities, low interest rate, a labour market facing lower structural wages and more service sector jobs, an increasingly reliance on government transfer payments, and higher taxes in the offing to pay for government-sponsored health insurance ...these are all bad signs for America's economy and its currency.

And by contrast, Australia looks downright bullish. So bullish, in fact, it appears to have cheered up Dr. Doom himself. Nouriel Roubini was in Kalgoorlie yesterday at the Diggers and Dealers conference signing Australia's resource praises. "As the global economy goes toward growth as opposed to recession, you are going to see further increases in commodity prices especially next year," he said.

Those commodity price increases - and the earnings that Aussie firms will generate from them - are what investors are queuing up for right now. It's what's sending stocks higher. But is it real growth or phantom growth?

We know that China is the world's biggest metals consumer. And we know that China's GDP grew in the second quarter at 7.9% and we know that China is spending hundreds of billions of dollars to keep its economy ticking over, employment full, and metals fully stock piled.

But what we don't know is if the world's economy has really reached the bottom of this debt-deflation cycle, where the bad investments and underperforming assets of the credit boom are written down, or off altogether. Is the balance sheet recession - the reduction of debt and the write down in assets bought with debt - really over?

That's the question. We'd suggest the answer is no. But then, it doesn't pay to argue with markets does it? The wretched performance of the U.S. dollar and dollar-denominated bonds leaves investors with a simple choice: speculate on other, riskier assets, or watch the value of your dollar-based savings erode.

So we have the era of forced speculation. It's a kind of dollar exodus. And anything that is not the dollar is a potential promised land. The upside - if you own oil, base metal, and commodity shares - is that there's a strong tailwind behind your investments.

The downside is that the speculation may not be based on real sustainable growth. It's just another lending bubble in China piled on the rubble of the real estate lending bubble in America. Bubbles built on rubble aren't stable. That means you may be better of trading the shares, rather than buying and holding and getting whipsawed by volatility. It's worth thinking about.

Not that we're complaining that shares are rising. But it's important to distinguish between a genuine bottom in the cycle and an epi-cycle, a mini asset boom in the middle of a broader bust (which is what we think this phase is). If it's one and not the other, your investment strategy and trading tactics would change.

The only real reason to whinge about it, from a value investor's perspective, is that it makes it harder to find under-bought bargains. Dirt cheap valuations and laggards are harder to find when a liquidity boom drives up all stocks. With so much cash coming in from the sidelines, it sure looks like a liquidity driven rally.

One asset that's especially confusing is oil. It's benefitting from its "not-the-dollar" status. But there are also, we believe, some fundamental reasons to like oil and energy stocks.

According to a recent article in Britain's Independent, "The world is heading for a catastrophic energy crunch that could cripple a global economic recovery because most of the major oil fields in the world have passed their peak production."

The report quotes Dr. Faith Birol, the chief economist at the International Energy Agency (IEA). Dr. Birol told the Independent that, "global production is likely to peak in about 10 years-at least a decade earlier than most governments had expected."

The IEA provided a detailed assessment of 800 major world oil fields. Those fields account for more than 75% of the world's proven oil reserves. The IEA concludes that that production at most of the biggest fields has already peaked and that, "the rate of decline in oil production is not running at nearly twice the pace as calculated just two years ago."

"On top of this," the Independent reports, "there is the problem of chronic underinvestment by oil producing countries, a feature that is set to result in an 'oil crunch' within the next five years."

Back in March we reckoned this underinvestment was going to lead to a spike in oil prices. There was the little matter of the super-contango in the oil futures market, where the futures price for oil was, briefly, nearly four times the spot price. This indicated that speculators and traders were betting on much higher oil prices later this year.

Since then, the futures price has declined a bit as the global economy proved more resistant to fiscal stimulus than first expected. But the spot price has soared. The contango has narrowed. But the net result is that oil is much higher. So what now?

The trouble with forced speculation is that it makes all asset prices more volatile. They are less driven by supply and demand and more driven by relative movements in other asset prices (currencies and bonds). But with oil, we prefer to keep our eye on the long-term supply picture. Why?

Barring a total collapse in industrial civilisation, it's safe to assume demand growth for oil will resume. You may not know when. But you know it will happen eventually.

Supply growth is a whole different mammal. Not only does the IEA report show that production at the world's major fields is declining faster than expected, it shows that traditional oil exporters are exporting less and consuming more of their own exports. When you combine those two factors with a resumption in demand growth - it leaves countries like Australia on the outside looking in.

Exporters are producing less and exporting less (at least that's the trend). And Australia must compete with large consumers like the U.S., India, China and Japan. Not a pretty position to be in. But for investors, it's not a nightmare either. The junior oil patch is heating up.

What about the rest of the market? Chart Partners Group Ltd. tells Bloomberg that the S&P/ASX 200 could plunge by as much as 19% in the next three months. It reckons the index will peak at 4,300 (about 1% up from here) and then hit 3,500 by October.

Keep in mind the whole thing is up 35% from a five-year low in March. A correction would be in order. But as reading the chart is not our game, we're going to get Swarm Trader Gabriel Andre on the case and report back to you tomorrow on what he says. Until then...

Dan Denning
for The Daily Reckoning Australia

• Higher Oil Prices, the New Normal
• Oil Price Chart Shows Slight “Correction” in Near Future
• Dollar’s Demise Has Started a Chain Reaction in Currency and Commodity Markets
• CRB Index Correction Likely to Go Further
• U.S. Dollar Strength or Oil Weakness?

But it is not Arab-style Wal-Marts who are responsible for the flood of "made-in-China" imports. It is instead individual Arab traders. Many of the traders can be found in Yiwu, a small Chinese city four-hours south of Shanghai. The city claims the world's largest wholesale consumer goods market selling the type of cheap gifts and household goods that sell in low-cost retail stores across the world.

Yiwu receives 200,000 Arab visitors annually. It is a virtual Arab market town with over a dozen Arabic restaurants lining its main street. However, the number of Arab visitors only started rising after 2001. Higher oil prices helped explain the increase, as they left Arab governments, and ultimately, Arab households with more money to spend on consumer goods.

However, visa restrictions were also important. How so? Western governments made it tougher for Arab traders to visit the West after September 2001 even as the Chinese government unofficially relaxed its visa policy. A few years ago, an Egyptian national might have taken 18 days or more to receive a visa to visit the United States. The same Egyptian could receive one to China in less than a day.

The number of Arab visitors to China surged as a result, filling up flights between Dubai and the main Chinese cities of Guangzhou, Shanghai, and Beijing.

The economic crisis has only intensified the trend. It's no wonder. The Middle East's imports from China are still growing, albeit in low single-digit figures, even as the United States imports from China collapse at near twenty percent rates relative to last year's levels. And Chinese manufactures are searching for new markets in the Middle East as a result. It is just one more sign of the change in demand.

Take Yang Linshan, for example, a fabrics manufacturer in the coastal province of Zhejiang. The Middle East now accounts for almost twenty percent of his exports. He is looking to set up a branch office in Dubai. Other manufacturers like Yang are meanwhile scouting for locations in the Middle East to build factories even as production costs at home rise. Egypt, with its low-cost workforce, is a particularly attractive investment destination.

There are other signs of the growing strength in trade relations. Wang Weishang, a local entrepreneur, also from the coastal province of Zhejiang, has set up Asia Business TV, a cable television channel. The channel broadcasts throughout the Middle East via Nilesat. It runs regular English-language promotional spots for Chinese products and services to the Middle East's traders.

It is individual stories such as these that help to underscore the depth of trade relations between China and the Middle East. And while the Middle East's $58 billion worth of purchases from China annually will grab headlines, it is the efforts of individuals like Yang Linshan and Wang Weishang that provide a more complete picture of strengthening economic relations between the two regions.

Yet economics is not the only area where relations are strengthening fast. China and the Middle East are also finding reasons to turn to each whether through culture, politics, or religion.

Take the Chinese author Song Hongbing. He believes the West is using its currency policy to prevent the East's rise. His best-selling Chinese-language book, Currency Wars, is being read by senior officials across China. The book includes such chapters as "Nuclear Finance: Target Tokyo" describing how the Plaza Accords, signed in 1985 between Japan and four Western nations, contributed to the collapse in the Japanese economy.

The book's ideas are not just popular in China. They are also popular in the Middle East.

I was reminded of this while recently watching Al Jazeera. Ahmed Mansour the anchor of No Limits, was interviewing the same Song Hongbing through a translator. Here was a Chinese author speaking on an Arabic-language TV program to an audience in the Middle East about how the West's currency policy has been used to suppress the East's rise. It was a remarkable exchange of ideas.

It was also a reminder that the Middle East no longer looks only to the West for inspiration. Egyptian President Hosni Mubarak has visited China nine times in the past two decades. The Syrian leadership has also long looked to China for inspiration hoping to learn from what President Bashar Assad called the 'Chinese experiment' on his visit to China in 2004.

Indeed, he is not the only Syrian official to visit China. Mohammad Dawood Al Sattam a member of the Baath Party Central Committee, visited Changsha, the capital of Hunan province, in late March. He was there on a study trip with fifteen other officials. Hunan is a major agricultural hub, land-locked, and famous for exporting labor to the country's coastal cities. Its economic reform experience was immediately relevant to the conditions that Al Sattam faces in his own province.

There is even talk in the Middle East of learning from China during the current economic crisis. An article on Islam Online in late April described how Chinese traders are increasingly common in Cairo and its outlying districts. The article, quoting several local professors, argued that Egypt's youth, or "shabab", should copy the work ethic of these Chinese traders as a solution to dealing with the economic crisis.

Certainly the relationship has its frictions. A flood of Chinese imports has resulted in the closure of many of Aleppo's traditional textile factories. The Syrian government has responded by imposing duties on select foreign textile imports rightly worried about the implications of job closures in a country where unofficial unemployment rates are estimated at upwards of twenty percent.

But there is hope. Production costs in China are rising. Land and labor are all increasingly expensive. The Chinese currency is also appreciating in value. Nearly 10,000 factories have closed down in the southern Guangdong province, neighboring Hong Kong, during the past year. More factories will close as the government is no longer willing to prop up low-value added manufacturers.

This is perhaps Syria's chance to emerge as an export manufacturing hub. It lies not far from Europe, one of the world's largest consumer markets. It may yet sign a trade agreement with the European Union. More Chinese manufacturers will invest in Syria if this permits them easy access to the European market. Chinese textiles manufacturers are, after all, already investing in Egypt.

Syria will never replace China. But it only has to capture a small share of China's trade with Europe to benefit. Consider this. China's exports to Europe have risen $225bn in the past decade. If Syria had captured just 1% of this trade it would have added 0.5 percentage points to the country's GDP growth annually, not to mention reduced chronic unemployment rates.

The upshot is that relations between China and the Middle East might be flourishing. Yet they are also delicately poised. The fact China has pushed the United States aside as the Middle East's largest supplier will rattle doors in Washington. But it is important to look beyond the trade figures to the social and political implications of this increasingly complex relationship.

Regards,

Ben Simpfendorfer
for The Daily Reckoning Australia

• Feds’ Attempt to Bail Out Consumers with Tax Rebates
• Chinese Economy Seems to be Growing
• Arab Wealth Pours Back into Dubai
• The New Chinese Era
• The Chinese and the Fed Both Buying U.S. Treasury Bonds

"The global mining industry will undergo mega deals of as much as $US10 billion ($15.38 billion) this year as the economic downturn presents once-in-a-lifetime acquisition opportunities," reports today's Age. It refers to a report by Ernst and Young in which the firms says it expects, "niche deals to increase and a number of smaller $US2 billion ($3.08 billion) to $US10 billion ($15.38 billion) megadeals involving the mid-tiers."

The consolidation makes sense. But it doesn't really help you figure out which resource is bullish or which firm is ripe for the taking. There is also the matter of the US$172 billion in loans outstanding held by resource extraction companies. The need to roll that over makes some firms vulnerable.

The EY report claims that draw downs in global commodity inventories, coupled with $2-3 trillion in global stimulus programs geared toward metals-intensive infrastructure programs is, well, bullish. That's probably true, but not in a way in which you could make accurate guesses about how much more iron ore or coal or zinc demand these plans will generate.

OPEC agreed not to cut oil production again until it meets later in May. That's a bit misleading, though. OPEC said it wouldn't cut production even though global oil inventories are high. But the friendly cartel members admitted they still haven't cut production down to the levels they agreed on with the previous cut.

Thus the nature of the cartel. It's in everyone's interest to cheat just a little bit by over-producing to make more money. Bloomberg reckons OPEC is producing about 800,000 bpd more than its agreed quota. "The crude oil production target for 11 OPEC members bound by quotas is 24.85 million barrels a day, while actual output from those countries averaged 25.715 million barrels a day in February."

For the arm-chair oil analyst, or just the casual observer of global petroleum markets, it's going to be an interesting ten years. OPEC still produces 40% of the world's crude oil each day. And its member nations control the lion's share of the world's proven oil reserves. Check out the table below.

Source: U.S Department of Energy, Energy Information Administration

On paper, you can see that just 17 countries control 1.2 trillion barrels of crude oil reserves. The ten OPEC nations on the list account for 924 billion barrels, or about 72% of total proved reserves. True, the Saudi proved reserve figures haven't changed in years, and are just as unaudited as all the gold in Fort Knox. The Saudi Oil Kings, like America's private bankers, refuse to let the public, or an independent third party, verify that they have what they say they have.

But let's not quibble. After all, Canada's reserve figure is based on the economic production of oil from the Athabasca Tar Sands. With the crash in oil prices, Canadian reserves are not looking so proved. You might say the same for some of the difficult-to-produce reserves in Russia.

Anyway, our point? It will be intriguing to see which falls faster in the coming years...actual production figures...or proved reserve figures. Actual production is falling because some of the world's big fields are in depletion. The proved reserves? Who knows what's going to be economically producible in the coming years? Look for more on the oil story later this week.

"There's no safer investment in the world than in the United States." Barack Obama's press secretary told the world, and especially the Chinese. He was speaking about U.S. Treasury notes and bonds. China owns around $700 billion in U.S. Treasury bonds, which is not only a lot, but more than any other foreign country.

Last week, Chinese Premier Wen Jiabao rattled some cages in Washington. He told a press conference in Beijing that, "We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets. To speak truthfully, I do indeed have some worries."

About 696 billion and counting, we reckon.

Is it possible the Treasury bond bubble has already burst? It is possible! If stocks can't sustain their rally from last week, then the institutional rush into bonds might resume. We wonder if people have quite given equities up for dead. But the chart below suggests that the move into bonds-at least U.S. government bonds-may have already come and gone.

Did the Bond Bubble Already Pop?

Source: ww.bigcharts.com

The chart shows the performance of a Barclay's ETF that tracks U.S. Treasury bonds of 20-years maturity or more. What you see in November is huge spike in prices as the stock market crashed and investors panicked.

What you see since then is a decline to lower lows and now, a period of indecision. "Should I stay or should I go?" It would be normal for institutions to keep cramming into bonds even as bond prices fell and equity prices climbed a wall of worry. But just because bond prices may have topped out does not mean we're giving the all-clear to get back into stocks. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• OPEC May Cut Oil Production
• How to Buy Crude Oil for US$2 a Barrel
• Higher Oil Prices, the New Normal
• Where Will Future Oil Production Come From and How Can Investors Profit Today?
• Pemex and Mexican Peak Oil Equal Expensive Oil

The Peak Oil story was never about running out of oil. It was about the collapse of complex systems in a world economy faced by the prospect of no further oil-fueled growth. It was something of a shock to many that the first complex system to fail would be banking, but the process is obvious: no more growth means no more ability to pay interest on credit... end of story, as Tony Soprano used to say.

There was a popular theory among Peak Oilers the last decade that the world would enter a "bumpy plateau" period when the global economy would get beaten down by Peak Oil, would then revive as "demand destruction" drove down oil prices, and would be beaten down again as oil prices shot up in response - with serial repetitions of the cycle, each beat-down taking economies lower - the only imaginable outcome being some sort of quiet homeostasis. This scenario did not play out as expected. It was predicated on a mistaken assumption that all systems would retain some kind of operational resilience while ratcheting down. Anyway, the banking system was mortally wounded in the first go-round and the behemoth is dying hard.

The last desperate act of the banking system in the face of Peak Oil's no-more-growth equation was to engineer species of tradable securities that could produce wealth out of thin air rather than productive activity. This was the alphabet soup of algorithm-derived frauds with vague and confounding names such as credit default swaps (CDSs), collateralized debt obligations (CDOs), structured investment vehicles (SIVs), and, of course, the basic filler, mortgage backed securities. The banking system is now choking to death on these delicacies.

The trouble is that the EMT squad brought in to rescue the banking system - that is, governments - can't remove these obstructions from the patient's craw. They don't want to drown in a mighty upchuck of the alphabet soup.

The collapse of complex systems is actually predicated on the idea that the systems would mutually reinforce each other's failures. This is now plain to see as the collapse of banking (that is, of both lending and debt service), has led to the collapse of commerce and manufacturing. The next systems to go will probably be farming, transportation, and the oil markets themselves (which constitute the system for allocating and distributing world energy resources). As these things seize up, the final system to go will be governance, at least at the highest levels.

If we're really lucky, human affairs will eventually reorganize at a lower scale of activity, governance, civility, and economy. Every week, the failure to recognize the nature of our predicament thrusts us further into the uncharted territory of hardship. The task of government right now is not to prop up doomed systems at their current scales of failure, but to prepare the public to rebuild our systems at smaller scales.

The net effect of the failures in banking is that a lot of people have less money than they expected they would have a year ago. This is bad enough, given our habits and practices of modern life. But what happens when farming collapses? The prospect for that is closer than most of us might realize. The way we produce our food has been organized at a scale that has ruinous consequences, not least its addiction to capital. Now that banking is in collapse, capital will be extremely scarce. Nobody in the cities reads farm news, or listens to farm reports on the radio. Guess what, though: we are entering the planting season. It will be interesting to learn how many farmers "out there" in the Cheeze Doodle belt are not able to secure loans for this year's crop.

My guess is that the disorder in agriculture will be pretty severe this year, especially since some of the world's most productive places - California, northern China, Argentina, the Australian grain belt - are caught in extremes of drought on top of capital shortages. If the U.S. government is going to try to make remedial policy for anything, it better start with agriculture, to promote local, smaller-scaled farming using methods that are much less dependent on oil byproducts and capital injections.

This will, of course, require a re-allocation of lands suitable for growing food. Our real estate market mechanisms could conceivably enable this to happen, but not without a coherent consensus that it is imperative to do so. If agribusiness as currently practiced doesn't founder on capital shortages, it will surely collapse on disruptions in the oil markets. President Obama at least made a start in the right direction by proposing to eliminate further subsidies to farmers above the $250,000 level. But the situation is really more acute. Surely the US Department of Agriculture already knows about it, but the public may not be interested until the shelves in the Piggly-Wiggly are bare - and then, of course, they'll go crazy.

The recent huge drop in oil prices has left the public once again convinced that the world is drowning in oil - if only the scoundrelly oil companies were forced to deliver it at reasonable prices. The public has been consistently deluded about this for decades. What's missing so far is for the president of the United States to lay out the reality of the situation in a dedicated TV address. I know a lot of you think that Jimmy Carter already tried this and failed to make an impression (and ruined his presidency in the process). I guarantee you that Mr. Obama will have to do this sometime in the next few years whether he likes or not, and he'd be well-advised to get it done sooner rather than later. And by this I don't mean just vague allusions to "energy independence" or "renewables" in speeches devoted to many other issues. I mean telling the public the plain truth that we'll never offset oil depletion and the intelligent response is to do everything possible to transition to walkable towns and public transit, not to sustain the unsustainable.

The alternatives - i.e. what we're trying now - is to further delude ourselves into thinking that we can run Wal-Mart and the suburbs by some other means than oil. Despite all our investments in these things, we won't be able to run them by other means, and the news about this had better get out before enormous disappointment turns into titanic rage. If Americans think they've been grifted by Goldman Sachs and Bernie Madoff, wait until they find out what a swindle the so-called "American Dream" of suburban life turns out to be.

This week, in the power centers of America, attention is fixed on the never-ending fiasco of AIG - a company whose main product turned out to be credit default swaps, and is now choking on them. Kibitzers on the sidelines of finance are forecasting a king-hell bear market suckers' rally in the stock markets followed by a belly flop to Dow 4000 or lower. I myself called for Dow 4000 two years ago - and was obviously a bit off on my timing. All this is surely trouble enough. But while your attention is focused on Rick Santelli in the Chicago trader's pit, or Larry Kudlow desperately seeking "mustard seeds" of new growth in financials, try to let one eye stray to the horizon where these other complex systems are working out their next moves. Farming. The oil markets. These are the coming theaters of alarm and distress.

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

• Peak Oil, Peak Food and Peak Everything Else
• Supply of Conventional Crude Oil is Very Close to its Peak
• Has Oil Hit Its Peak Price?
• Peak Oil: Supply Data Doesn’t Lie
• A View from the Peak of the Global Economy

ASIC acknowledged that short sellers can help a market find its lows more efficiently by targeting badly managed firms and exposing flawed models. However, it concluded that, "Any possible loss of market efficiency or price discovery as the result of the continuation of the ban is justified given the current market circumstances". Those current market circumstances, by the way, are that stocks are falling like a stone anyway.

Justification by faith alone.

A revision to our recession reporting from yesterday. We said the ABS reported that the Australian economy contracted by 0.1% in the fourth quarter. It was actually 0.5%.

In any event, the hubbub over whether the economic performance conforms to a textbook definition of a recession is, well, stupid. Imagine you're in a plane that's lost power to its engines and is falling from a sky. "Don't worry," the passenger next to you says, "it's not a crash until we've become a smoking hole in the ground."

There is a large amount of denial or obliviousness in the media about just how terrified businesses are. Our prediction: massive waves of layoffs and redundancies this year. Or, if you prefer the politically correct term now in vogue with human resource managers, a lot of employees are about to be 'dis-established.'

Seriously. We didn't make that up.

Hey what's this? Oil prices were up nearly 9% in New York, or about US$3.73 a barrel to $45 a barrel. OPEC production cuts and inventory reductions have brought global supply more into line with global demand (which is dramatically reduced owning to the world financial calamity).

Oil in Contango, Headed Higher

You might not have noticed, but oil has been in "contango" for awhile now. That's a trader's term that describes a situation where the futures price of a commodity is higher than the spot price. There are several reasons why this might be the case for oil.

One obvious reason is that traders look at the chart above-and global financial crisis not withstanding-see the oil market moving back into equilibrium (reduced supply, stabilised demand). Lately, there is some hope that China's stimulus package reignites industrial production or at least commodity demand (although we wouldn't count on that.)

There's also a more macroeconomic reason to expect higher oil prices. Global monetary policy is pretty accommodating at the moment. There is a great debate over whether or not this will lead to higher inflation in real tangible goods. If you're on one particular side of the debate, you'd expect a big increase in the money supply to lead to higher general prices, especially for commodities like oil. Thus the higher futures price.

Of all the explanations for the contango, the one that makes the most sense to us is actually the most indirect. The oil price crash of 2008 has virtually guaranteed future supply constraints. As major integrated oil companies cut back exploration budgets, and as unconventional energy alternatives got put out of business by the crashing price of crude, the foundation was laid for a massive spike in oil prices sometime later this year.

That spike won't come from some unexpected recovery in demand or global growth. It will come from chronic production declines from the world's oil industry and national oil companies. More on that next week. In the meantime, the contango is narrowing in the sense that spot prices are catching up with futures prices. There are still some trades to be made, though.

Yes. It's possible all of this is wrong, including our forecast that gold will rise and U.S. Treasuries are in the formative stages of an uber bubble. It's possible that the Feds and the pollies have sorted out a precision one-two combination to deal with crisis.

With a left job, the Fed and central banks provide lending and liquidity to the banking sector and the business world. Some of this lending is securitised by real collateral. What it means, practically, is that the central banks backstop the short-term financing needs of the real economy for as long as it's necessary to organically repair bank balance sheets (or extract nasty tumours from them).

This is what the Term Auction Lending Facility (TALF) is designed to do in the States. If it works, you'll notice it by declining spreads between government debt and corporate debt (among other things). You wouldn't expect an explosion of new lending from banks. Prudential standards will have to be reviewed, including capital adequacy. But it would be a long, slow, return to a boring, risk-averse business model.

All the bad loans and bad assets, by the way, would be sent off to the financial equivalent of a FEMA trailer camp/prison where they will either be rehabilitated or never heard from again.

And with the right upper cut? Fiscal policy of course! More stimuli, more mortgage cram downs or first buyer grants (here in Australia). For example, last night the Treasury Department in America announced a vague US$75 billion plan to stem the rising tide of defaults and foreclosures.

We're not saying it will work. After all, one in five American homeowners is underwater on his mortgage. You cannot legally refinance when you have negative equity (so that law will have to be suspended or re-written). But one way or another, showers of cash will fall on the newly unemployed or the dangerously indebted.

And maybe, given enough time, this one-two combination will paper things over. It will leave a massive legacy of public debt and insure years of much lower economic growth, not to mention government claiming a much larger slice of GDP. But this seems to be the plan. Knock the problem out with a relentless one-two combo until the crisis, the economy, or the people are pummelled into submission.

In this scenario, we think you'll see one sovereign currency after another go down the global toilet as governments expand their debt-to-GDP ratios and devalue via huge public spending increases. The yen, the pound, the euro, the dollar, and gold. Which will reach the bottom last?

Right now, ye olden greenback looks like it could last the longest of the paper currencies. Global capital is queuing up to get into sovereign U.S. bonds. The global fiat system looks like it has one last big bubble in it. More on that tomorrow.

Reader mail.

Dear DR

Do you think that there is a possibility that the current world economic downturn could lead to something more than a recession/depression i.e. a total breakdown of some of the societies worst affected (e.g. UK and the US), or perhaps a total collapse of world trade resulting in each country having to be essentially self sufficient? There seem to be a lot of writers talking about the US specifically totally falling apart and having martial law imposed.

Clearly the mainstream media massively underplay the scope of the collapse that has and is happening but do you think that such extreme scenarios mentioned above are credible predictions or just overdramatising?

Best wishes

Steve Hall

London

Yes.

Dan Denning
for The Daily Reckoning Australia

• No Spike in Oil Price Following IEA “Third Oil Shock” Announcement
• Peak Oil: Supply Data Doesn’t Lie
• Oil Prices Under $70
• U.S. Dollar Index Showing All Sorts of Weakness
• The Coming Oil Back Draft

If, on the other hand, you want to know why oil prices could double this year, or how $52 trillion in total global debt will utterly suffocate central bank attempts to resuscitate bank lending, or Ben Bernanke's secret plan to turn trillions of dollars worth of toxic assets into shareholder equity, read on!

You're still with us? Good. Now, why are oil prices lying?

Prices communicate information. The NYMEX February oil contract fell over 5% today in New York trading to $34.40. This suggests oil is falling in value, at least in the short term. And maybe that's not totally a lie.

After all, the current oil price results from two factors. First, the absence of leverage from the oil futures market leaves prices reflecting immediate supply and demand. With inventories full, the market seems well supplied (so much so that OPEC is cutting production). Second, the reality that oil demand will be flat or slightly fall this year because of the worldwide financial pandemic.

Adequate supply plus stagnant demand equals $35 oil. So why is the December 2010 oil contract trading nearly 80% higher at $61.80? What could possibly happen between now and December 2010 that would cause oil to go up 80%?

Well, for one thing you might be in the early stages of an economic recovery by then. Demand would have recovered. Shares could be higher. Everything could be fine.

But we can think of at least three reasons why the current oil price is headed much higher this year (not in 2010). First, the lower oil price is actually going to lead to lower oil production later this year and next. Oil production is declining to begin with. But the crash in prices has put the kibosh on exploration and production.

Second, as Diggers and Drillers contributor Mike Graham explains in a January article on the subject, the clear trend within the oil market is that historical exporters are exporting less oil. There are several reasons for this, which Mike gets into in his story.

One is that oil exporters are hoarding it now and waiting for higher prices later. Another is that oil exporters are consuming more of their own production, leaving less for export. And still a third reason is that the world's largest oil exporters face declining production trends thanks to...you guessed it...Peak Oil.

Yes. Peak Oil has not gone away. It's been sent to the corner while the Credit Depression hogs the stage. But Goldman Sachs oil analyst Jeffrey Currie issued a report yesterday predicting a, "swift and violent rise" in oil prices in the second half of 2009.

Currie told a conference in London that, ""Thirty dollar oil reflects the same imbalances that got us to $147 oil. The problems haven't gone away. We still believe the day of reckoning is to come." What problems?

There are still major infrastructure bottlenecks in the global oil network. Currie says that despite the big fall off in demand, "This is not 1982-1983 all over again. The supply picture's radically different...the demand picture's radically different. The key difference is that today there are no large-scale next generation projects that are going to save the world. Commodity demand is exponentially higher than it was."

This brings us to the third reason oil prices should rise later this year: the oil trade is back on. Sure, credit may still be a scarce commodity. But if you judge traders by their actions, you can see the market is setting up for a big oil back draft. As evidence, Bloomberg reports that, "Morgan Stanley hired a super tanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said."

Our friend Dan Amoss back in America calls this the oil arbitrage trade, where supply is stockpiled offshore, and thus withheld from refiners, allowing existing gasoline inventories to be worked down. Then in six to twelve months time, when crude prices have moved higher, you simply park your ship at the terminal and cash in on the difference between what you paid six months ago (today) and the new market price.

It is normal for the oil futures to be in contango, where spot prices are lower than futures prices. What's less normal is the amount of oil being stockpiled offshore. "Frontline Ltd., the world's biggest owner of supertankers, said Jan. 14 about 80 million barrels of crude oil are being stored in tankers, the most in 20 years," Bloomberg ads.

We also suspect that oil as an inflation hedge will come back into vogue later this year, which might be adding to the appeal of buying today at bargain basement prices. What's more, you can never discount (although you can never fully quantify) the geopolitical aspect of oil prices. A good general rule of thumb is the more war there is in the Middle East, the more likely oil is to go higher.

So what should you do? That's the subject of the January issue of Diggers and Drillers. More on that after we publish it for subscribers first later this week.

Next is a massive topic we are reluctant to introduce today. But we have to. There is no other way around it. It begins with a question: how much air is left in the credit bubble?

Actually, the question comes via Howard Ruff and Steve Hochberg. Let's start with Hochberg.

He's the lead analyst at Elliott Wave International. Bob Prechter's folks have been forecasting for years that the collapse of the credit bubble would lead to a general and massive deflation, including much lower gold prices. In his latest analysis, courtesy of a DR Reader, Hochberg explains:

"The systemic build up of total market credit is so large, currently about $52 trillion, that its implosion will swamp the Fed's attempts to inflate. And as CTC [Conquer the Crash] discusses, the remaining dollars that are not extinguished through bankruptcy, restructuring and write-offs, will increase in value. The thirst for cash will be insatiable relative to all other assets.

"Initially, the Fed's attempt to inflate was akin to using a garden hose to refill Lake Mead after the Hoover Dam collapsed. Over the past five months the chart shows that the Fed has graduated to a fire hose. But creating just over $2 trillion in the face of a contracting pool of $52 trillion in total credit market debt is just not going to get the job done, and the only thing getting hosed right now is us."

" Eventually credit will contract to the point whereby the income generated from economic production will be able to sustain it and at that point, yes, the U.S. dollar should indeed collapse of the weight of all the Fed's machinations and gold should soar. But before the market arrives at that point, deflation must run its course. In our opinion, there is still a long way to go."

But how far? A lot depends on the composition of that $52 trillion in credit. It can't all just vanish can it? But how much of it is securitised by relatively stable assets? And how much of it could potentially melt away under the intense heat of deflation?

This is not an easy question to answer. But it begins with knowing what you're dealing with. Specifically, you have to know who owes how much, and who owns how much. Those are two different questions. Let's deal with the first one. And we promise we'll make this as painless as possible. If you want to review this data yourself, by the way, you can find it here.

Keep in mind this data deals just with the U.S. And keep in mind it is government data. But the general question is this: how much deflation is left in the credit bubble and who stands the most to lose from it?

The Fed breaks up the total credit market debt outstanding into three categories: Domestic Nonfinancial Sectors (households, farms, nonfinancial corporations, state and local governments, and the Federal government), Financial Sectors (commercial banking, REITs, broker dealers, savings institutions, Government sponsored enterprise, Agency and GSE pools, and issuers of asset backed securities), and finally, the rest of the world.

What we find is that $32.9 trillion in credit market debt outstanding, as of the third quarter in 2008, was owed by the domestic non-financial sector. That's 63% of the $52 trillion total. Households are on the hook for most of that, with $13.9 trillion owed (or 26% of all credit market debt outstanding). That would mostly be home mortgages we reckon.

Next within the financial sector are non-financial corporate businesses with $7 trillion, non-farm corporate businesses at $3.7 trillion, state and local governments at $2.2 trillion, and the United States Federal government at $5.5 trillion.

So what does it tell us? Well it tells us that if U.S. house prices continue to fall, there is a lot of room left to deflate in the credit bubble, at least several trillion dollars. It's not hard to see this happening, given the rise in foreclosures, the prospect of even less federal funding for refinancing of mortgages, and the sudden collapse of America's banking model.

But the lack of credit for refinancing and the looming wave of Alt-A recasts this year and next is, in some sense, already old news. What also keeps us up at night is the $16 trillion in credit owed by the financial sectors. How much of that is at risk to further deflation?

You can get an idea by looking at the L2 table on page 59 of the Flow of Funds report. There is $6 trillion in corporate bonds outstanding. Nearly $5 trillion in Agency and GSE-backed securitised mortgage pools are on the books, and another $3.1 trillion in GSE debt itself. This does not include $1 trillion in "other loans and advances" which may or may not include home equity lines of credit.

We're sure you get the picture by now. There is still at least $8 trillion housing related assets owed by the financial sector. That might be kind of tough to pay off, given the falling value of the assets which securitise that debt. So who stands the most to lose if households can't pay their mortgages, corporations default on their bonds, and housing-related assets held by financial corporations continue to fall?

The financial sector combined holds $37 trillion in credit market "assets." It owns $37 trillion in other people's promises to pay. Those promises, all $37 trillion of them, are on the books at face value. What's more, U.S.-chartered commercial banks (Citibank, Bank of America for example) own $8.2 trillion in credit market "assets." Life insurance companies own another $2.9 trillion. Money market mutual funds own $2.1 trillion in credit market assets, while mutual funds own $2.3 trillion.

Do you see what we're getting at? The institutions that have the most to lose from a fall in the value of their credit market "assets" also have large obligations to shareholders and pensioners. Those institutions are counting on those assets to meet their own future liabilities (which do not fluctuate in value). And households are relying on those assets to retire, or in some cases, to live month-to-month on a fixed income.

Someone is going to lose, somehow. Or everyone will.

Households win if the value of the credit they owe (their mortgage) is written down or managed lower by some new law. But investors counting on that asset (often the household itself through a pension or life insurance) don't win if the amount they are owed is arbitrarily reduced.

Either way, Prechter's group is probably right. There is more deflation ahead. A lot of it. And not just in housing.

The corporate bond market would be another place to look. Corporate defaults haven't begun to rise noticeably yet. But faced with a much slower economy and much higher borrowing costs, it's going to be tough for highly indebted firms to roll over their debt, much less take on anything new. Dividends are already being slashed here in Australia.

And where does the deflation of the $52 trillion credit bubble leave us? Well Howard Ruff reckons we get a period of serious deflation, punctuated by a period of hyperinflation. Over at Kitco, he writes that, "First, we will continue to plunge into a major deflation period which will be characterized as a 'recession,' and later in the year as a 'depression.' Deflation and inflation are always monetary phenomena."

"Second, deflation will evolve into a run-away-hyper-inflationary depression because of what government will do to try to prevent deflation, which is synonymous with depression and has overtones of the 1930s."

How will government accomplish that? More on it tomorrow. Meanwhile, and finally, some timely reader mail.

"why do your emails have to be so long winded.... they waffle on toooo [sic] much, one metaphore [sic] after another... can any one really be bothered in there busy lives readin [sic] over all that.... I actually find some of the factual input useful, but there isnt [sic] much of that... a friendly tip, cut your newsletters/emails by 80%, get to the point and lose the metaphores [sic] and long winded useless stories.... the genuine potential investors your trying to pull in wont [sic] be inpressed [sic] with such dragged out point of views...I am a member of a well known share forum, many think the same as I do... the dailyreckoning could do allot [sic] better, it has so much potential, yet your [sic] boring people..."

Zzzz. Huh? What's that? Oh yes, this free daily e-mail about world historic financial events is too long and won't impress interested investors.

First, a tip. Maybe you should spend more time on spelling and grammar. But that is beside the point.

Sure the Daily Reckoning can be long. And we're grateful that you invite us into your living room and office each day to hear what we read. We don't take your time for granted, which is why put time and effort into what we write. And some times it takes time and effort to unwind a complicated subject.

If we had more time, the DR would be shorter. And in fact, we'd like to launch a subscription-based DR later this year. It would be a shorter, more to-the-point version of the DR with action to take. But in the meantime, we don't have the time for a shorter DR! So you'll have to deal with the long one. Or watch television instead. Your choice, if you're still reading that is.

Dan Denning,
for The Daily Reckoning Australia

• What is the Oil Price Telling Us?
• Pemex and Mexican Peak Oil Equal Expensive Oil
• The Coming Oil Back Draft
• No Spike in Oil Price Following IEA “Third Oil Shock” Announcement
• Oil Prices Under $70

Here in Colorado you'll find the same stories that preoccupy Aussies: the share market, the property market, and jobs. Fuel prices are down. But the animal spirits that animated markets and people just a few years ago are visibly subdued. It could also be that the cold has frozen everyone's facial muscles.

You'd also think that the 77% fall in oil prices from their all-time high would be unmitigated good news for consumers and the economy. But that is especially not the case in energy states like Colorado. High oil prices meant increased exploration and production for coal, gas, and oil.

Now, the big oil majors are re-thinking projects. Projects that made sense with the oil price at $90 now make a lot less sense with the oil price hovering above $30. Thus you have the irony that lower oil prices will lead to more consumer use but less major production. Lower prices, then, will accelerate the rate of depletion in proven oil supplies but not ad substantially to the search for new elephant fields.

That doesn't sound good does it?

What else? People are buying at the big box retail outlets, reports your editor's sister. She's taken a part-time job at one of them. Her husband works in the mortgage department at Wells Fargo. She reports that people are buying, but mostly food.

"Lots of bulk food items. Batteries, water, those sorts of things. And they're paying cash."

We'll have more to say tomorrow after we get settled in. For now...over to....

Dan Denning
for The Daily Reckoning Australia

• Higher Oil Prices, the New Normal
• No Spike in Oil Price Following IEA “Third Oil Shock” Announcement
• Oil Prices Under $70
• BHP Billiton: The Oil Company That is Not an Oil Company
• Oil Prices Has The Mogambo Guru Sticking His Thumb in His Eye

Despite the fact that the Dow and S&P 500 were able to overcome yesterday's unfortunate data, ending slightly up as the closing bell rang, this morning was a different story all together. Concerns over the what effect the weak economy will have on corporate profits hit the overseas markets hard. Japan's Nikkei index tanked 9.6% and European shares plunged about 7% this morning.

The gloom over growth expectation is now worldwide...says one expert:

"Periods of panic punctuated by occasional calm appears to be the manner of the things for now."

The Dow, S&P and Nasdaq futures all fell so much that they set off the "circuit breaker rules". In other words, the exchanges reached pre-specified limits that can't be broken until pit trading starts. However, once trading opens, all bets are off. Hence, the 'bloodbath'.

You how the saying goes: America sneezes, and the rest of the world catches a cold. It might be time to stock up on tissues...we are looking at a case of walking pneumonia.

*** The FOMC is meeting next week and the general consensus is that they will indeed cut rates. Really, how could they not? But some speculate that they will go where no Fed has gone before: below 1%.

"Everyone at the Fed has pretty much told you they're going to cut," said Rich Yamarone, director of economic research at Argus Research. "They're in kitchen sink mode now. Rate cuts, fiscal stimulus, bailouts - they're throwing in everything they can right now."

However, there's a chance that lowering rates below 1% won't even make a blip on the radar in the United States' struggling economy...rate cuts just aren't as important as they once were.

"It's a window dressing, only a psychological weapon," said Sung Won Sohn, economics professor at Cal State University Channel Islands. "Right now, the problem isn't the cost of the Fed's money, it's that the existing money supply isn't circulating. The pipelines are clogged."

*** The price of oil fell below $65 a barrel today, even though OPEC decided to cut oil production by 1.5 million barrels a day starting next month. The black goo is selling for 50% less than it was just a few months ago due to a pretty major crimp in global demand.

In a statement released by OPEC they said: "Oil prices have witnessed a dramatic collapse - unprecedented in speed and magnitude. This slowdown in demand is serving to exacerbate the situation in a market which has been oversupplied with crude for some time."

The saving grace here could be the recent dollar strength. Today, the greenback rose against most major currencies - except for the yen. The yen rose to a 13-year high against the dollar overnight.

"The Japanese currency also surged against the euro after Belarus, Ukraine, Hungary and Iceland joined Pakistan in requesting at least $20 billion of emergency loans from the IMF. Fear that pressures in Eastern Europe will have a negative effect on Euroland is another reason the euro continues to drift lower vs. the US$. European banks lending to emerging markets is about 21 percent of GDP and UK banks loans are around 24%, compared to 4% for the US and 5% for Japan. Eastern European currencies continue to be under speculative attack, and the currency markets are selling the Euro due to its close relationships to these emerging markets."

*** The signs of the difficult economic times the United States is facing is showing up everywhere...and most likely at your favorite restaurant as well. Chris Mayer explains:

"The convulsing U.S. economy is really the big topic of conversation everywhere. It's affecting all kinds of businesses now. Anthony Bourdain, whose book Kitchen Confidential is one of my favorites, recently talked about how the economy is affecting the restaurant business. He was at Caesar's Palace in Atlantic City doing some kind of cooking demonstration. Afterward, he offered some thoughts on what the recession will bring: 'There are going to be a number of real sea changes in the business model of the fine-dining restaurants, and in basic menus. The proportions are going to change, the menu selections are going to change.'

"The upside to this? 'Cooks will learn to how to cook shanks and shoulders and hooves and snouts well.' In other words, they'll learn to really cook using things previously discarded. It has long been a theme running through Bourdain's books and his TV show that great cooks (and great food) emerge from essentially poorer cultures. Whether it is the budgetary constraints or shortages or lack of certain ingredients, these cooks must be more creative. They learn skills that cooks in richer circumstances never learn. Brilliant cooks and wonderful dishes are born in such environments.

"What does this have to do with investing? Well, besides simply noting the ripple effects of Wall Street's self-immolation, I think that living through this environment will make you a better investor. Anybody can invest when things are going well - a lot of skills don't matter when the markets are rising. But when things get dicey, it suddenly becomes important again to understand what you're buying and to know how to value assets.

"Right now, there is still a tremendous amount of fear out there, which leads to valuations far removed from underlying business values. If you can't get excited about some of the values on your screen now, I'm not sure what you're hoping for."

*** Yesterday, everyone's favorite former Fed chief testified in front of the House committee about the nation's worsening credit crisis.

"We are in the midst of a once-in-a-century credit tsunami," he said to the House Oversight and Reform Committee.

That said, Big Al believes that the United States will emerge from this crisis with a "far sounder financial system." And that he was "shocked" that the financial system broke down.

However, some Committee members weren't buying Ol'Bubbles song and dance (and neither were you, dear reader - but more on that below).

CNN reports that in his opening statement, Rep. Henry Waxman, D-Calif., committee chairman, opined that the current crisis could have been prevented "if regulators had paid more attention and intervened with responsible legislation. The list of regulatory mistakes and misjudgments is long and the cost to taxpayers and the economy is staggering."

By and far, you agree with this sentiment. We asked yesterday for our long-time DR sufferers to write in about your thoughts to Greenspan's testimony...and here's what you had to say:

"I think Big Al and the Federal Reserve's lending practices are largely part of the blame," writes one DR reader.

"It was the Federal Reserves practice of lending money out for virtually free (1% for over a year) that I believe was the core problem that fueled all of the rest of the items that Big All mentioned. Guess he forgot to mention that item.

"Then Bernanke took over (realizing that the housing market was becoming way over valued) and raised the overnight lending rate 0.25 % every time they met till they finally 'popped' the housing bubble (which needed to be popped, but way to late). You can see it on the chart.

See this key interest rate chart at bankrate.com from 2001 to 2008:

"I guess it was fun while it lasted!"

Writes another:

"As always the case with Mr. Greenspan it is not what he says but what he is not saying.

"He is not telling that he supported (reckless) lending by offering money below inflation rate.

"He is not telling that people should not trust rating agencies because they are paid by the issuer.

"He is not telling that his oversight on the financial market was insufficient and lax.

"The mistakes he mentioned others made are surely lessons to learn from.

"But no doubt in my opinion; Mr. Greenspan is one of the main culprits originating this crisis."

And another: "Yes Greenspan is full of it but what a 'maestro'. After whipping the morons on the hill over and over through the years (they were afraid to parse his babble for fear of looking uninformed or stupid) Greenspan mea culpas that his 'free market' philosophy let him down. Har har har har har har har!!! He feeds them gibberish in which he now supports more regulation after having virtually blown up the world through incompetence and self-serving water carrying for his masters. Now he lays it at the feet of the 'free market' in one of the most managed economies on the earth. The dopes on the hill are used to beating up on slow-witted baseball players so this was easy for Mr. Maestro. Out the door he went without a single mention of the guillotine as a fitting punishment."

We'll leave you on that uplifting note...have a great weekend!

Short Fuse

The Daily Reckoning Australia

• Hank Paulson’s Desperate Measures to Save His Friends on Wall Street
• Wall Street Snubs Obama
• Ranting Against Free markets and Wall Street
• How to Become a Better Investor: The Wall Street Journal Effect
• Barack Obama and His Nobel Peace Prize