Our story begins with "Peak Oil" - the belief that conventional production of crude has already peaked, and has already slipped into an irreversible decline. As "Peak Oil" moves from mere theory to indisputable fact, the global economy will face wrenching changes. But the vigilant investor will gain an opportunity to profit along the way.

As I discussed in yesterday's edition of The Daily Reckoning, oil production seems all-but-certain to decline, despite the huge new discoveries off the coasts of Brazil, Africa and elsewhere. In fact, production is already declining rapidly from some of the world's largest fields. Mexico's "Catarell" Field, like a kind of Peak Oil poster child, was producing more than 2 million barrels a day as recently as 2005. But production from this field is plummeting irreversibly toward 500,000 barrels a day, as the chart below illustrates.

The recent discoveries of deep offshore oil will certainly help slow the decline of conventional crude oil production, but theses discoveries will not come on line for many, many years.

But what about alternative energy sources? Won't they make up for the shortfall of crude oil? No chance. Alternative energies might offset a tiny sliver of falling crude oil production. But solar panels can't lift a fully loaded Boeing 777 off a runway...nor even lift an empty Piper Cub.

So what about the many sources of "unconventional" oil and gas? Won't these compensate for declining production from conventional sources? The short answer is no.

Geologist Art Berman, for example, offers a decidedly negative view of the latest "big thing" - obtaining large volumes of natural gas from "tight shales." In a comprehensive review of production and flow rates from several thousand wells drilled in the past decade in the Barnett Shale of Texas, Mr. Berman presents a gloomy forecast.

Looking at a large sampling of Barnett wells, the overall data reveal that initial gas flows decline rapidly. With some wells, the drop-off is as much as 70% in the first year, with further declines of 20% in the second year.

This hardly dovetails with the happy talk about how "shale gas" will supply US energy requirements for the next several decades, if not a couple of centuries. It appears that most Barnett wells are short-term money losers, with a few prolific wells carrying the bulk of capital expenditure.

According to Mr. Berman, the picture is not much better in other shale plays, such as the Fayetteville and Haynesville shales. And similar gloomy data are just now starting to come in on the embryonic gas play in the giant Marcellus formation of Pennsylvania.

But this bad news does need to be ALL bad. As the world's mature and aging oil fields slip into an irreversible decline, production from the world's new offshore discoveries will become increasingly important.

Therefore, forward-looking investors can begin TODAY to make selective investments in those sectors of the oil industry that will flourish during the coming oil shock. I am particularly fond of the "deepwater" sector...and have been urging my subscribers for several months to focus on the companies that facilitate deepwater oil production.

Marcio Mello, the former "explorationist" from Petrobras (PBR: NYSE) and now independent petroleum consultant, electrified the Denver meeting of the Association for the Study of Peak Oil & Gas (ASPO) with his analysis of several high-profile deepwater discoveries.

In a riveting talk that lasted well over an hour, Marcio detailed the immense petroleum potential of offshore Brazil, as well as the Amazon Basin. If Marcio's estimates are correct, Brazil may be the location of nearly 200 billion barrels of additional petroleum resources. That's well within the range of current resource estimates for Saudi Arabia.

For good measure, Marcio described the petroleum potential of offshore West Africa - another 130 billion barrels - as well as the Congo region, with 50 billion barrels or more.

Finally, Marcio described the "unknown potential of the US back yard, the Gulf of Mexico (GOM)." Marcio offered remarkable insight into the deep regions of the GOM, 100 miles and more offshore Texas and Louisiana. He showed early work he performed on a number of GOM areas, including the site of BP's (BP: NYSE) recent billion-plus barrel find at the Tiber site.

If his analyses of the South American, African and GOM petroleum systems are correct, the world has access to much more conventional oil than people previously believed. But accessing and producing this oil will require a trillion-dollar level of offshore, deepwater investment. It's a 30- to 50-year project.

"Deepwater" will be a BIG business.

Some of the companies that are well-positioned for the deepwater era of crude oil production include Petrobras, Repsol (REP: NYSE), BP (BP: NYSE) and StatoilHydro (STO: NYSE). I am also a fan of subsea equipment builders like Cameron Intl. (CAM: NYSE) and FMC Technologies (FTI: NYSE), plus service companies like Halliburton (HAL: NYSE) and Baker Hughes (BHI: NYSE).

These are a few of my favorite long-term plays for the long-term era of deep-water development.

Regards,

Byron King,
for The Daily Reckoning Australia

• Peak Oil – The Risks
• Supply of Conventional Crude Oil is Very Close to its Peak
• Peak Oil: Supply Data Doesn’t Lie
• Where Will Future Oil Production Come From and How Can Investors Profit Today? Part 2
• Pemex and Mexican Peak Oil Equal Expensive Oil

"What?" we replied to one of our analysts this morning.

"He's the only Storm Trooper named in the Star Wars movie. I bought a card board cut out of him pointing his laser rifle at you. It was on sale the Science Works exhibit. I've put him behind your desk to remind you that you're under the gun."

True enough. It's not just your editor under the gun, though. What's at stake this week is whether attempts by governments and central banks to prevent more credit writedowns have succeeded. If they have, it could prevent the further transmission of the credit crisis from the financial sector to the real economy. And for investors, it could kick off a Great Releveraging.

Are we changing our tune, then, about what to expect from markets? Not one bit. But the question now is timing. The collapse of 2008 was so severe because of the sudden reduction in leverage in the financial sector. As assets fell in value, the most highly leveraged firms (or lenders who raised money by selling debt) went out of business.

This kicked off a chain reaction in which other market players were forced to sell assets and preserve capital. Banks preserve capital by not lending. This is how the credit crisis "jumped" from the financial sector the medium and small businesses (those not big enough or politically connected enough to qualify for government bailouts). And from businesses the deleveraging crisis went straight to households, who began saving more and cutting back spending.

And now it comes full circle. When households cut back, it eats into corporate profits and bank profits. Households with members who've been fired get behind on bills. Securitised credit card receivables, car loans, and mortgages - a large chunk of bank assets - start to go pear shaped. And banks face more credit writedowns, accelerating the cycle.

This is the cycle the Feds and global monetary authorities set out to short circuit this time last year. Their main objective: increase asset prices to stabilise bank balance sheets and prevent the spread of the credit crisis. How did they do it? TALF, TARP, CAP, the suspension of mark-to-market accounting rules, and the maintenance of low interest rates (in the States especially).

All these clearly did support asset prices, and especially allowed banks to post a quarter two of quarter over quarter earnings growth. This has created the appearance of stability. But what has not improved one bit is the quality of those bank assets purchased with borrowed money. There will be more writedowns to come. But when?

We should entertain the possibility that the Feds can support asset prices for some time. Take Australian housing for example. This week the Federal government announced that it would chuck another $8 billion in taxpayer money to purchase residential mortgage-backed securities (RMBS). Treasurer Wayne Swan says he's doing it to support "the home lending market."

We'd say he's doing it to keep money flowing into the housing sector so builders stay busy, banks stay profitable, and house prices stay high. Remember, this subsidy to non-bank lenders in the RMBS market is there because other investors won't fund these lenders. And why would they when the government is happy to put your money on the line.

The government says the securities are collateralised by high-quality residential real estate. But that's what pretty much anyone who was hawking this kind of debt said in the U.S. for the three years of peak mortgage issuance. This is how real estate - traditionally a local industry where prices vary from place to place - becomes a national market - through the nationalisation of the mortgage bubble. A national mortgage bubble can inflate house prices across the board-making the entire country vulnerable to higher interest rates and/or a credit crisis.

Here you see the public sector adding debt while the private sector scales back. Also, in Australia, there is still widespread public belief that house prices only ever go up. That means the government can support lending because borrowers are still borrowing. This just makes the inevitable house price correction much more devastating. The borrowers with the smallest margin for error are going to be hurt the most.

Here's something else to think about: what happens when the stimulus spending dries up? Treasury Secretary Ken Henry says that the economy could lose another 100,000 jobs and that the withdrawal of stimulus spending will shave 1.5% off Australian GDP in 2010. This is another way of saying the peak effect of the stimulus (in terms of supporting both consumer demand and employment) was in middle two quarters of the year.

So how will Aussie consumers and businesses behave when the stimulus is withdrawn? Did the Rudd government give the economy just enough free money smack to keep its credit high going? Or will the comedown be just around the corner around Christmas? If they're cautious, Australians will put away their wallets and cut up the credit cards and reduce spending growth to match income growth. The retail sector and retail stocks will be hit hard.

There's one other big question for investors heading into the end of the year. We know the government can support some sectors more effectively than others. Big ticket items like housing and cars can be subsidised with tax rebates or, in the case of housing, with a fresh injection of credit to support politically connected non-bank lenders in the RMBS market.

But you have to reckon the economy boosting effects of supporting the housing market are limited. The main beneficiaries are the banks and the builders. Granted, if you're a politician, those are two important constituencies to keep happy. But what about the rest of the economy?

The basic question is how much of it will stand on its own two feet once you remove the stimulus. The stimulus, the FHOG, the government backing of the RMBS market...these are all attempts to revive an economic growth model that's dependent on asset inflation and credit bubbles. That's the model that led to the bubble that led to the bust.

Papering offer the holes blasted in bank balance sheets by the credit crisis seems to have worked in terms of restoring confidence. Call it a successful psychological operation by the government spin doctors and their buddies in the media and banking. The whole purpose of the operation was to appear to recapitalise banks to healthy levels. But really it was to prevent the banks from having to take further credit writedowns, which itself feeds the process of forced asset sales, declining asset prices, and more household deleveraging.

One immediate risk to watch for is Australia's resource export industry. Export volumes are down year. But for the largest export categories, last year's contract prices are still in effect. Looking forward, 2010 could see lower export volumes AND lower prices for bulk commodities like iron ore and coal (especially if Chinese inventory restocking is complete). This would make the current valuations on resource earnings look pretty generous. You'll read more this week on which sectors are going to thrive and fail in this Great Releveraging.

Back to gold and the dollar and the new world currency order. A simple question: what was all the fuss about last week with a new reserve currency anyway? Here is an answer. If OPEC demands payment for oil in something other than U.S. dollars, then people who buy oil (and who doesn't?) have to stockpile the other currencies in which oil is priced and traded. That would be pretty tough on America.

To support its oil appetite, the U.S. would have to buy the currencies in which oil is priced. It couldn't use good old greenbacks. How do you buy foreign currencies?

Well, you can sell your assets (gold, real estate, stocks) and use the money to pay for oil. This is what Australia does. Or you can borrow in a foreign currency (did anyone say future Chinese bond market?) It's also possible you can use earnings on your foreign-owned assets - provided those assets generate enough money to support your oil habit.

These are all options within the free market system. The main point is that all other things being equal, you have to sell something to pay for something. This is why the foundation for economic health is always wealth production, not consumption. Production creates the goods that facilitate the trade that creates the profits to increase purchasing power for the things you don't produce.

But outside the free market system, you could opt for just taking the oil by force. By that we meant that should the U.S. be put in the position of having to pay for oil with new borrowings or asset sales, it might take the geopolitical path of least resistance and resort to a good old fashioned overt resource war. The declining Empire will strike back with its principal remaining asset, its military.

Likely candidates for an oil war? Not Iran. It's too far away. There are too many U.S. troops in Iraq and Afghanistan that would become targets. And the effect of a Middle East war would be too destabilising on oil prices. But Venezuela, on the other hand, is much closer to home.

Granted, comrade Obama is a peace maker. He was a won a price for it. Peace be upon him. And it would not seem like he's not likely to attack his good friend Comrade Chavez.

But if the current president flounders in the fiscal morass he finds himself in, he'll be a one term savior. Some pundits are already calling him "America's Gorbachev." He's the man who will preside over the swift fall from grace of a Superpower.

There will be no second coming (term). And that leaves room for a challenge from a more hawkish member of his own party (Hillary Clinton) or a populist Republican with a handy doctrine of liberty within the hemisphere (let's call it the Palin Doctrine). If Obama is America's Gorbachev, who is America's Putin? That's what Glenn Reynolds at www.instapundit.com is asking.

Naturally all of this is pure speculation. But our main point is that the oil game is not just a currency game. It's a power game. And it's silly to think the U.S. would relinquish its control over the oil market so easily. There will be a fight.

Not that the U.S. could maintain the reserve currency status quo by force. But sooner or later someone at the policy level in America is going to realise that once the reserve currency status is lost, the country loses a huge strategic and competitive advantage. Its standard of living, already in major decline, would face a major body blow.

Just how American policy makers plan on maintaining that advantage is yet to be seen. Of course maybe they don't plan on it at all. The Empire could be so narcissistic and full of false confidence that few people fail to see the inevitable chain of events the country faces. You'll just get more spending and more chest-thumping and more fiddling. Or more war.

Dan Denning
for The Daily Reckoning Australia

• Banks Could Face Larger Asset Writedowns and Losses than IMF has Modelled
• Gold Sales Cost Europe’s Central Banks Billions
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Everyone is Busily Debasing Their Currency
• The Greatness of a Depression is Commensurate to the Government’s Efforts to Prevent It

Qatar's greatest asset is its natural gas reserves. In fact, the largest gas field in the world is here. Its discoverers were disappointed when they found it in 1971. They were looking for oil.

The boom Qatar now enjoys is the result of some daring investments in liquefied natural gas (LNG) back when people thought doing such a thing was a little batty. Faisal Al Suwaidi, the head of Qatargas, deserves the props for his wager, which have paid off handsomely. Today, Qatar produces about one-quarter of the world's natural gas.

Qatar supplies such faraway customers as Japan, India and China. Qatargas also operates the largest LNG terminal in Europe at South Hook on the Welsh coast. This facility provides Britain with a fifth of its gas needs.

Qatar's dominant position has filled its coffers and changed the country forever. On a per capital basis, it is one of the wealthiest countries in the world. And given the world's growing energy demands and the appeal of clean-burning (and cheaper) natural gas when compared with oil, Qatar seems in a good position.

In Dubai, the story is quite different, as Dubai does not have Qatar's gas reserves, nor does it have much oil. Dubai's story is one of trade and finance.

As I write, the sun is just peeking over the horizon. It is dawn in Dubai. Out my hotel window, I can see two buildings with cranes over them and in the distance another building in scaffolding. For a city that was once booming and turned bust - as with most places - there is still a lot of construction going on.

As recently as September 2008, realtors could claim that no one had lost money in the Dubai property market. That's no longer true. In fact, now the market has too much of just about every property type. One headline story noted how 32,000 homes are about to come on the market next year, which is a big number to choke down in any city. Dubai had a huge property boom and now must suffer the flip side.

The hotels, too, are pretty empty. We are staying at the new Address Hotel downtown, which has been open for only 25 days, we are told. I'm the first person to stay in my room. It still has that new carpet smell.

I wandered down for breakfast and was alone in a cavernous dining room. The hotel is brand-spanking new and everything looks wonderful. It's just mostly empty. I think there are more hotel workers than there are guests.

In Dubai, revenue per room is down 35% from a year ago. Yet there is still an expansion going on. Next year, estimates call for a 15% increase in the number of rooms. This would mean a 40% increase in two years.

Over breakfast, I perused my complimentary copy of The National. One of the things I like to do in a foreign city is to read the local newspapers. I'm kind of a newspaper junkie anyway - I get three dailies delivered to my doorstep at home. In any event, I always find interesting nuggets from a perspective you might not get if all you read is The Wall Street Journal or Financial Times.

Today's business page carried an array of tales... There was the arrival in Doha of a new LNG tanker, fresh from Seoul's shipbuilding docks. There was a story about how UAE consumer confidence is up. Also, notes on bond issues in the Gulf, the latest figures on money supply in Kuwait (it's rising at a frighteningly quick pace of 18.7%), the price of villas in Dubai and more. All sorts of little odds and ends that help paint the picture.

There was also a lot of chatter about infrastructure, which I found particularly interesting. Abu Dhabi, the capital of the UAE, which I will visit on this trip, is looking to raise $100 billion for infrastructure projects. From The National: "The emirate needs to fund new transport, electricity and telecommunications schemes..."

Dubai itself also has ambitious infrastructure spending plans. Last night, as we made our way to our hotel, we could see the new Dubai Metro stops along the way, which, lit up as they were in soft blue and white twinkling lights, looked like something out of the future.

Incredibly, the Dubai government last year spent about 45% of its budget on infrastructure projects - mostly on the roads and ports. But there is a lot more on tap, as The National reports:

"Dubai could invest as much as $20 billion in desalination projects in the next decade alone as it increases its water output by 2.72 billion liters a day... [There are also] plans to add 14,405 megawatts by 2017... Construction costs for those new plants amount to $11.6 billion, while infrastructure costs, including substations and transmission lines, will be about $11.6 billion."

This massive build-out is not unique to Dubai, or even the UAE. There are also big infrastructure projects of all kinds in India and China and other emerging markets.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• Arab Wealth Pours Back into Dubai
• Dubai and Abu Dhabi: Newcomers to the Global Finance and Trade
• Is Dubai the Bubble It’s Made Out to be?
• DMCC and their Precious Metals Vault
• The Inflation Rate in India is Running About 12%

"It's a chart."

"Right. What is it telling you?"

"A lot of things. It'll be easier if I just send you the conclusion..."

So later, he did. His note began, "Oil is up. Stocks are up. But here is the trading question: is Woodside and petroleum a buy at these levels? To answer that, you have to look at WPL and oil side by side.

"A simple comparison of the Brent crude price and WPL (see below) shows how impressive Woody's rally has been from the lows. We can see that in Fibonacci terms (useful for tracking a stock's movement over a discrete period) Woody's has retraced to its .618 of the whole move down from all time highs. In comparison oil hasn't even reached its .382 retracement. Advantage Woodside.

"You've also seen a big rally in the Australian dollar over this time. This lowers Woody's AUD earnings. But the stock is being priced for growth anyway. Investors are obviously starting to appreciate the long term value and growth in WPL over the next few years. And why not? The long term story for WPL remains very sound and one that I would want to be exposed to.

Click to enlarge

"Having said that, WPL may have gotten a bit ahead of itself at these levels. The stock price is resting on the top of the channel. And you can see the stock has moved up and down-but always stayed within-that channel since the lows of 2008. With the stock at the top of the channel now, you'd want to be cautious about entering any longs. The risk is that the stock tests the top of the channel, fails (as it has done consistently) and moves to retest the lows.

"If Woodside is ahead of itself, what about oil? The chart shows that oil itself is looking weak and could see a retest of recent lows around $60. This would definitely put some pressure on WPL. But that's not all bad news if you don't have a long term position in WPL already.

Click to enlarge

"If WPL is to maintain its current uptrend we could easily see a pullback towards $45. That could provide a good risk/reward buying opportunity. You get the stock you want to own. But you get it a technically good time, without overpaying or buying in before it retests the lows.

"But a resumption of the downtrend in the overall market could see even lower levels for the stock. And that is the big risk right now. Even though WPL is a stock you should own as a long-term energy bull, there will be an opportunity to buy it at better levels in the future. If you own it now, you ought to either take some profits off the table or prepare to have your conviction challenged.

Dan Denning
for The Daily Reckoning Australia

• The Only Thing Really Going Down Right Now is the U.S. Dollar
• Big Difference Between Stark News in Job Market and Behaviour of Stock Market
• S&P 500 Heading Towards Some Major Long Term Resistance Levels
• Profiting From the Copper Indecision
• How to Trade Gold Shares

But let's not forget about oil. It too is priced in dollars. In fact, the big gold move started because Robert Fisk claimed the Gulf States and China et al. are tired of paying for oil in an unstable currency. You could say that gold moved closer to being money again because of how important oil already is to the real economy.

We'll get back to oil in a moment. But there was a story in today's Age that gave us the willies. "The Aussie dollar is poised to storm past parity with the US dollar, propelled by local interest rate rises and Australia's close ties to the booming Chinese economy, according to currency analysts," reports Chris Zappone.

It doesn't sound too creepy. But there IS a creeping hint of euphoria to the Aussie story at the moment. The dollar...the economy...the fact that summer is just over the horizon...you can feel the animal spirits getting friskier. It was like this in the summer of 2008 as well, right before the bottom fell out.

But enough of the weird sense of déjà vu. How does the big picture affect your investments? That is always the tricky part. It's one reason why we are stuffing our new offices with all kinds of traders and analysts and writers whose ideas would probably get them thrown out of a respectable job. These are just the people we want thinking about the investment future.

Dan Denning
for The Daily Reckoning Australia

• Gold, the Aussie Dollar, the Greenback and You
• Aussie Dollar is Crushing Long-time Rivals Like the Pound and the U.S. Dollar
• Dollar’s Demise Has Started a Chain Reaction in Currency and Commodity Markets
• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• The Aussie Dollar as a Measure of Global Risk Appetite

Where have all the jobs gone
long time passing
Where have all the jobs gone
long time ago
Where have all the jobs gone
Gone to graveyards everyone
When will they ever return
Oh when will they ever return

- Sung to the tune of "Where Have All the Flowers Gone?"

"Many lost jobs in US will never come back..." says The Wall Street Journal.

Need we explain why? Because they're not lost, waiting to be rediscovered. They're not missing in action, to be repatriated after the fighting stops. Instead, they're dead. Gone forever.

There have been 7.2 million jobs lost since recession began. Many of these jobs were Bubble Age jobs. Millions of people, for example, earned their money in 'housing.' They were putting up houses in the sand states...or building granite countertops...or selling, flipping, financing the houses. Those jobs are gone forever. Never again in our lifetimes are we likely to see such an explosion in the housing industry. Sure, people will still build houses...and do all the other work involved in the traditional housing industry. But it will be only a fraction of the industry it was in the 2002-2007 period.

There were also all the jobs involved in selling things to people who didn't need them and couldn't afford them. Labor was needed at every step of the way - manufacturing (perhaps in China), shipping, stocking, retailing, fixing, and financing the stuff.

And don't forget all that mall space...and all the trucks...and all the other things that supported the over-consumption of the Bubble Age.

And now the Bubble Age is over. It will not come back, no matter how much cash and credit the feds pump into the system. (Not that they can't make things worse...in a BIGGER bubble...but that is not yet in sight.)

In The Wall Street Journal yesterday was an item about Las Vegas. The casinos are folding up their expansion plans, says the WSJ.

But the big news yesterday was that the service industries are growing again...at least that's what the latest figures show. This news so delighted investors that they bid up Dow stocks 112 points. Oil rose above $70. Gold posted a $13 gain.

Don't get too excited about that rise in the service sector. Everything bounces...even dead jobs. Dead jobs bounce; they still don't get up. After months of decline, it may be true that the service industries have had a rebound, but don't expect them to begin recovering the stamina and strength of the bubble years. A few more people may have gotten jobs serving drinks in Detroit's bars last month, but it is not likely to turn into a durable recovery of the job market.

In the 1990s, the US economy added 2.15 million new jobs every year. It needed to add at least 1.5 million or so just to remain at full employment - that is, with about 5% of the workforce unemployed at any time.

To put that number in perspective, this year the economy as LOST 2.5 million jobs, just in the last six months. Those jobs aren't coming back. As we keep saying, this is a depression. It is a major correction, in which the economy needs to find new jobs...because it can't continue to do what it has been doing.

New jobs are typically created by new businesses - small businesses that are growing. Big businesses already have all the market share they're going to get. They also typically have all the employees they need. Then, when hard times come, they discover that they don't need all that they have, so they cut back.

Job cuts from large businesses is what you expect in a recession. But this time it is different. This time, big businesses have let people go by the million. But small business has not been hiring them either. So not only is unemployment growing...the trend shows no signs of coming to an end.

Economists are reconciled to high unemployment levels for a long time. The head of the IMF says unemployment might peak out in 8 to 12 months. Even if that were true, it will be a very long time before the job market recovers. Just do the math.

We'll keep it simple. The economy needs, say, 1.5 million new jobs per year. Instead, over the last two years, it lost 7.5 million. Now, it has to stop losing jobs...let's just say that happens a year from now. By then, the total of jobs lost may be near 10 million. Plus, there are the new jobs it needed - but never got - over that 3 year period. That's another 4.5 million. So, the total will be about 14.5 million jobs down. Then, let us say, because we are in a generous and optimistic mood, that the economy then begins creating jobs again...at the rate it did during the '90s. What ho! After five years, that still leaves the economy more than 10 million jobs short, doesn't it?

In order to get back to full employment, the economy has to surprise us on the upside. It has not merely to return to the growth levels of the '90s...it has to surpass them. It needs to grow so fast it creates 3 million jobs per year. And even then, it would take nearly 10 years to get back to full employment.

Pretty grim, huh?

Well, don't worry about it. It won't be like that. It will be worse.

"Uh...Bill...what do you mean, 'worse'?"

Glad you asked.

In the typical post-war recession, jobs are lost...then they are recovered when the economy gets on its feet again. But this happened in the credit expansion of the '45-'07 period. Each recession was just a pause, when the economy was catching its breath. Then, it was off again...in the same direction - up the mountain of credit.

This time, it's not a typical post-war recession. It's something different. Now, we've reached the peak. We're coming down the other side...wheee! Look out below!

Now we don't need all those people building houses, stocking the shelves and selling things. We don't need such a big financial industry either. Now, people want to get rid of credit, not get more.

And the businesses that were goosed up in the credit bubble are now deflating fast. They're not just taking a break. They're lining up the jobs and shooting them in the back of the head. Those jobs are gone. (See below...)

In a 'normal' recession, jobs reappear because the economy continues in the same direction. In a depression, it changes course. Debts are paid off. Spending goes down, more or less permanently. The economy actually contracts...until consumer debt is once again down at an acceptable level...or a new model for growth can be found.

The Wall Street Journal mentions a statistician who was making $100,000 a year. He too is a victim of depression. His job has been outsourced to India. Businesses, with less revenue coming in the door, must cut costs in whatever way they can. Labor is the single biggest item on most firms' ledgers. They will reduce it however they can. And once the change is made, there is little chance that the job will come back.

It is a little like a battle. In an attack, troops often get separated. They are 'lost' - for a while. Then, the winning side is able to recover its missing troops as it advances. But the losing side gives up its troops forever. They are stuck behind enemy lines and cannot rejoin their units.

We are now on the losing side of a credit battle. Having gained so much ground, and so many jobs, in the advance, the United States is now giving them up.

"I expect over the next several months, mainstream pundits and forecasters will start worrying about tepid hiring, even as the pace of job losses slows," Strategic Short Report's Dan Amoss chimes in. "As we 'lap' the 2009 corporate cost cutting by early 2010, and top lines fail to rebound, earnings estimates will have to come back down. I'm amazed at how many sell-side analysts are modeling V-shaped recoveries in 2010 earnings. Most stock prices are disconnected from reality."

And here is a story we foretold years ago. Private equity was mostly a fraud, we said. Sharp operators bought companies for more than they were worth, loaded them with debt, collected huge fees, and then sold them back to the public or to other private equity firms. Come the revolution, we mused, these deals would go bad.

Well, the revolution has come. The deals have gone bad. The New York Times reports:

"Simmons [the mattress company] says it will soon file for bankruptcy protection, as part of an agreement by its current owners to sell the company - the seventh time it has been sold in a little more than two decades - all after being owned for short periods by a parade of different investment groups, known as private equity firms, which try to buy undervalued companies, mostly with borrowed money.

"For many of the company's investors, the sale will be a disaster. Its bondholders alone stand to lose more than $575 million. The company's downfall has also devastated employees like Noble Rogers, who worked for 22 years at Simmons, most of that time at a factory outside Atlanta. He is one of 1,000 employees - more than one-quarter of the work force - laid off last year.

"But Thomas H. Lee Partners of Boston has not only escaped unscathed, it has made a profit. The investment firm, which bought Simmons in 2003, has pocketed around $77 million in profit, even as the company's fortunes have declined. THL collected hundreds of millions of dollars from the company in the form of special dividends. It also paid itself millions more in fees, first for buying the company, then for helping run it. Last year, the firm even gave itself a small raise.

"Wall Street investment banks also cashed in. They collected millions for helping to arrange the takeovers and for selling the bonds that made those deals possible. All told, the various private equity owners have made around $750 million in profits from Simmons over the years."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Normally Small Businesses Lead the Economy Out of Recession
• Job Losses From Private-sector Rose Since Beginning of Recession
• One of the Biggest Humbugs in Capitalism is Private Equity
• Predictions for a Polite and Mild Recession
• Investors Think Things Will Return to the Way They Were in the Bubble Epoque

Starring Ben Bernanke, Tim Geithner and a cast of millions...

The new movie - Zombieland - about a group of survivors in a world of zombies, was the biggest grossing film in America and Canada over the weekend. It must reflect the zeitgeist of the North American public...a deep feeling that we are living in a decaying world.

Maybe it comes from the growing awareness that the old bubble economy of the 2002-2007 period is dead. Now, survivors must defend themselves from the zombies.

Survivors are being attacked in the streets, in their homes, and at their workplaces. Zombie banks - kept alive by artificial stimulants provided by the feds - take their money and their houses. Living-dead companies block new competitors. And the zombies at the Fed and the Treasury department try to gnaw on their savings, encouraging inflation to eat away the purchasing power of the dollar.

As to this last point, the feds have gotten nowhere. They wear down their teeth for nothing. Prices are going down, not up. Houses are 30% cheaper than they were in 2006. Hotel rooms are 20% cheaper than last year. You want a luxury room? Just ask for an upgrade. Chances are good that no one is renting the luxury suites. Just make them an offer. Discounts are available almost everywhere. The Sony Playstation, for example, is now available - 25% off.

Stocks are cheaper too. They've been going up for the last seven months, but they're still about a third less than they were in 2007.

Stocks fell again on Friday. Investors began to fret that maybe...just maybe...the authorities don't have this zombie problem under control.

"Jobs news gets worse," The New York Times tells us.

Since the stock market began going back up in March, the United States has lost 2.5 million jobs. It has lost jobs every month since December 2007. Now, unemployment - officially at one in ten workers - is the worst it has been in 26 years.

What kind of recovery is this? We don't know, but if it continues much longer we'll all be unemployed.

But not to worry, dear reader. Secretary of the Treasury Tim Geithner says the signs of recovery are "stronger" than expected.

We wonder what signs he's looking at. Of course, this is the same doctor who was on the scene at the New York Fed when strange things began happening. The financial industry started acting funny in the bubble years...spending money like there was no tomorrow. And then, wouldn't you know it, there wasn't any tomorrow. They dropped dead in the crash of '07-'08. But with huge injections from the Fed, they've turned into Zombies.

Of course, Tim Geithner missed the whole thing. So maybe he's not the best source of recovery sightings.

A survey by Business Roundtable tells us that the ranks of the unemployed are likely to swell. Only 13% of employers have plans to hire more workers. The rest are either sitting tight...or turning workers loose.

Naturally, of all those people cut off from paychecks, more than a few are looking a little peaked. Their eyes sink back in their heads. Their skin turns grey. Soon, they're starving for raw meat.

"Personal bankruptcies soar," says The Wall Street Journal.

And not surprisingly, when they become desperate, they tend to default on their mortgages. We know already that auto sales drove off a cliff when the summertime 'Cash for Clunkers' program came to an end. Now, summer's over. Housing sales should decline too - forcing more homeowners into default and foreclosure.

The zombies are having a depressing effect everywhere. The stock market went down again on Friday...the Dow fell 21 points. The oil market didn't do much better, with the price of the black good still below $70.

As for gold, the yellow metal continues to hold above $1,000. It fell below $1,0 00 for just a couple days. On Friday, it was back to $1,004.

The $1,000 level used to be a ceiling for the gold price. Now it seems like a floor. Are the Chinese buying below $1,000? Maybe. Do we have a Beijing put option available to us? That is, has the risk been taken out of the gold market by China's desire to stock its vault with something other than dollars? It is an intriguing thought. We don't know the answer.

We are holding onto our gold. It's insurance - protection against the feds. If they do something really stupid, the price of gold will soar. If they don't do anything really stupid, well, we'll be surprised. After all, they've already turned America into Zombieland.

Bill Bonner
for The Daily Reckoning Australia

• A Dispatch from the Zombie Wars
• Where, Exactly, is this Economy Headed?
• Funny Business at the Banks
• Economy Has to Grow at 1% to Stay Even With Population Growth
• Unemployment Rate at a Five Year High

Two important things happened yesterday, both of which cast a crimson light on things.

First, the Dow dropped again; it has only gone up one of the last 7 days. It went down 203 points. Could be nothing. Could be something big...the beginning of the long awaited 'next leg down' for the bear market...the opening day of a bloody Red October.

Charts of oil, commodities, copper, the dollar, and Treasury bonds tell us the same story. The greed investments are topping out. The fear investments are headed up.

What's a 'greed investment?' It's anything that benefits from an improving outlook for the economy and inflation - oil, commodities, and stocks, mainly.

What's a 'fear investment?' It's something that goes up when people begin to suspect the boom is a phony - namely the dollar and US Treasury bonds.

The dollar is rising. So are Treasuries. Yesterday, 30-year US Treasury bond yields fell below 4% for the first time since April.

And what about gold?

Well, that's the other important thing that happened yesterday. Gold held above $1,000.

So what?

So what?? Well, dear reader, you are in a prickly mood this morning, aren't you?

This is important because gold could go either way. Gold is a refuge in times of fear - especially when people fear inflation or a falling dollar. Gold is also a target of greedy speculators sometimes, even when the going is good. According to a study done by the World Gold Council, you never know what gold will do. That study was a great comfort to us here at The Daily Reckoning; we thought we might have missed something. But no. We may not know what gold will do, but neither does anyone else.

Looking around, we see no sign of consumer price inflation. So gold's recent rise must have been driven by optimistic speculation - along with oil and stocks. Now, when oil and stocks go down... we have to wonder whether gold will go down too. The answer, given yesterday, was what we expected - yes, but not as much.

There's substantial risk in gold as well as stocks. The ultimate low for the Dow should be below 5,000. That is, let's say, about a 50% haircut from current levels. And let's assume that gold does what it did yesterday...let's suppose that it goes down only 40% as much as stocks. That would still be a drop of 50% of 40%, or 20% - to the $800- an-ounce level.

If you would be gravely upset by a drop of that magnitude...you probably shouldn't buy gold at this level. And, of course, you should have sold your stocks already. Stick to cash - and gold, if you're long-term oriented - until this next phase is over.

The economic news was mixed, as usual...with nothing to make us think that our basic outlook is wrong.

On the optimistic, bullish side...consumer spending rose in August. Pending homes sales went up too.

But on the pessimistic, bearish side... "September auto sales plunge," says a Reuters headline. Yes, auto sales drove off a cliff last month - just like we said they would. GM reported a 47% drop.

What happened? The clunkers program was an economic fraud. Like all attempts to boost consumption, it merely shifted sales from the future to the present (now the past). Which is a big reason why August consumer spending looked good too.

But wait a few weeks for the September consumer spending numbers. Especially if the stock market continues to fall... Then we'll find out how sustainable those retail sales numbers really are.

As you know, here at The Daily Reckoning headquarters...in the building with the gold balls on the south side of the Thames...we are often accused of 'pessimism.' We deny it. We're optimistic about the fate of mankind. But we are pessimistic about many of his current pretensions - such as health food, enlightened central banking, contemporary art, mass education, global climate control and progressive democratic government.

But maybe we are wrong to be optimists. Pessimists always have the last laugh - when the optimists die. "I told you so," they say, under their last breath.

Bill Bonner
for The Daily Reckoning Australia

• Is Gold Going Up Because People Fear Inflation?
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Abandoned Shopping Malls to Follow Abandoned Houses
• China Stepping Up Purchases of U.S. Treasury Debt
• September is the Best Month for Gold

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
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We said we were doing some serious thinking this week. Maybe it is the season. But more and more, our thoughts become grayer. Less black. Less white. Less hard. Less soft.

A few years ago, it looked to us as though the world financial system had gone to war. We cheerfully awaited the victory parade. We figured Mr. Market would whup the feds good and hard. It hasn't happened so far.

On one side, are the forces of a natural market correction...following a long, long period of expansion. The easier money gets, the more people tend to misspend and mis-invest it. Then, inevitably, their mistakes must be corrected. That's what bear markets and recessions are for.

But the feds don't like bear markets or recessions. And at least since the Keynes outlined his general theory back in the early 20th century, they've believed that they don't have to put up with them. Keynes took a page from the Old Testament. Government should act like an enlightened Egyptian Pharaoh, he didn't say, but should have. It should run surpluses in the fat years and deficits in the lean years...thus flattening out the pattern of boom and bust.

Pharaoh was no dope. He stored up grain for seven years, when the harvests were bountiful. Then, when the seven lean years came, he released the grain to the people. Problem solved.

Keynes believed that modern government could do the same thing. But Pharaoh was not running a democracy. He had no voters to answer to. So, if he wanted to store grain in the fat years, he could do so.

In theory, the US government could do the same. But, in fact, it never runs significant surpluses. There are too many people who want too much bread and too many circuses. And you don't win votes by denying the voters what they want. So, in practice, the feds run deficits even in the fat years! Last year, before the downturn really started to bite, the US federal government ran the biggest deficit in history - nearly half a trillion dollars.

Now, let's imagine how that would work for a bad Pharaoh. He would give out grain in the fat years. This would encourage farmers to produce less grain. Then, when the lean years came, Pharaoh would have no grain to give out...and the farmers would have less grain stored up themselves, since they grew less during the boom years. The famine would be worse than ever.

Then, if we can imagine that Egypt was trading with China at the time, perhaps Pharaoh could borrow grain from the Zhou dynasty to help ease the peoples' pain. Perhaps he could mortgage the pyramids. Whatever, he - and the Egyptian people - would have been in much better position if he had done as Joseph told him in the first place...lay up stores in good times, then draw them out in bad times. How difficult is that?

But Bernanke didn't see the famine coming. Neither did Geithner. Or Greenspan. Or any of the other savants Pharaoh used to interpret his dreams. None of them expected hard times. None of them warned the public. None of them encouraged the government to save money for the recession. Nassim Taleb asks why Bernanke was reappointed after he clearly failed the most critical test. But heck...the federal government is an equal opportunity employer. Employees aren't let go just become they're incompetent.

Anyway, getting back to our thoughts...

..it looked like a battle to us - between the forces of inflation (the feds)...and the forces of deflation (the market). But battles usually have clear winners. One side is master of the field and the other retreats. One side is victorious; the other is defeated.

Alas, some wars produce no hosannas of success...and no wailing widows of failure. Some end in draws...or in confusion...or in disgrace and bankruptcy for both sides.

Like the bad Pharaoh, the feds saved nothing. Now, they have to try to work their Keynesian magic on credit. This puts them in a weak position; like a government that wages war on borrowed money. They can continue their campaign only as long as lenders allow them. They can't wage the war as effectively as they'd like. Then again, maybe they can't lose it as spectacularly as they might.

For the moment, their credit is still good. The bond market foresees an inflation rate of less than 2%. Bankers, taking money from the government, are happy to lend it back to them.

But the forces of the correction are giving up little ground. While stocks rally, the real economy remains in a funk.

"Sharp drop in start-ups," is a news headline from yesterday. New business start-ups are a major source of new jobs. Bad omen.

Even glamour publisher Conde Nast is forced to make cutbacks. It has told employees that they may not spend more than $1,000 a night when they are traveling.

A Pimco economist says savings rates are still going up...and may exceed 8%. This represents hundreds of billions of dollars taken out of the consumer economy. Oddly, while it makes the slump worse, it also helps finance the government's battle against it. Savers buy US debt (albeit indirectly).

So, the battle is still going on...and the outcome is still in doubt.

Bill Bonner
for The Daily Reckoning Australia

• On the Evidence, Stimulus Programs Aren’t Working
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• Historically, the Only Reserve a Central Bank Can Trust is Gold
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