But let's start with sovereign wealth fund of China, the China Investment Corporation (CIC). CIC was set up in 2007 with US$200 billion of China's nearly $2 trillion foreign exchange reserves. It's been shopping ever since, with mixed results. Last year, for example, CIC stood pat and only invested US$4.8 billion outside China. It preferred to ride the bubble in Chinese bank stocks, which worked out pretty well for it.

Yesterday, however, Reuters reports that CIC is now cashed up to the tune of $300 billion and ready to buy again. "It will not be too bad this year," says CIC chairman Lou Jinwei. And here's the good part. "Both China and America are addressing bubbles and we're just taking advantage of that. So we can't lose...We have to be in everything because you never know what's going to happen in this world."

Come again?

There's a charitable way of reading these comments and there's a straight forward way. The charitable way is that Lou and the rest of China's economic mangers know that their $2 trillion in forex reserves (which are mostly in U.S. dollars) are in perpetual danger of devaluation. If you had a pocket full of $300 billion in monopoly money, trading it for anything-anything at all-would be the sensible strategy.

You'd want to trade it for a real tangible assets or equity before asset sellers started treating your money with disdain. This is why CIC "can't lose." Better to trade it for something now then watch it turn into nothing later.

The straightforward interpretation is that the Chinese wealth fund managers have lost their marbles. Counting on more bubbles to increase your wealth is a portfolio destruction strategy. Chinese fund managers may end up being every bit as stupid as the hedge fund managers and bankers and CEOs at U.S. banks who ran their respective institutions into the ground making the worst leveraged bet of the century on U.S. housing.

The only real difference, as far as we can see, is that the U.S. bets were made with borrowed money (often borrowed from Chinese creditors, we reckon), whereas China is investing the fruits of its productive labour over the last twenty years. It is a massive gamble. The U.S. managers, who may have been criminal rather than stupid, did tremendous damage to their country's economy. Will China's managers replicate the feat?

This also makes you wonder how much the emergence of China itself is a function of a global bubble in fiat money since August of 1971, when Richard Nixon took the U.S. dollar off the gold standard. Sure, there are tens of millions of Chinese people working in real factories making real products out of real raw materials (many sourced in Australia). These people have real dreams, ambitions, and economic aspirations, not to mention real savings (in gold and paper money).

But is it possible that China's time at the centre of the global economic stage is limited because China's economic model itself always depended on cheap credit and fiat money? Yes, yes. It goes against the whole "next economic empire" way of thinking. But if China's official asset managers are counting on bubbles to make them wealthier, you wonder how sound the model is, and how long the wealth will last. We wonder anyway, which is our main job at the DR.

Empires. They sure don't make them like they used to. Rome lasted a good long while, with a big lead up as Republic. The 1,000 year Reich didn't last ten years. The economic and political clock seems to be speeding up these days.

That would be something. A twenty-year global boom from fiat money that simply accelerated the depletion of natural resources and the misallocation of capital to projects that are uneconomic at lower levels of household and business debt. Hmmn.

Speaking of resources, two notes that prove oil is still out there, but getting harder to find and more expensive to produce. PetroChina will spend $2 billion to buy a 60% stake in the MacKay River and Dover oil sands projects in Canada's Athabasca oil sands. Canadian sources reckon there are 5 billion barrels of bitumen on the properties. But turning bitumen into oil isn't easy or cheap. It takes lots of water and energy, neither of which are money.

The other note is that BP says it has found as much as three billion barrels of oil in the Gulf of Mexico. It found it by drilling 10,685 metres below the Gulf of Mexico, or 35,000 feet. So BP drilled the equivalent of a Mt. Everest underwater to find the oil. Actually, Mt. Everest plus another six thousand feet.

This is ample evidence of Peak Oil. It shows that oil is getting harder to find and more expensive to produce. Technology has improved, of course, allowing exploration companies to look further afield than ever before. Oil companies can increase reserves this way. They're finding oil. But it is not the cheap, easy, free-flowing stuff once found in the oil fields of East Texas or Saudi Arabia.

By the way, if you're wondering what could cause a second dip in the global recession, we have an answer: government stimulus. Yesterday was full of stories on how the stimulus spending by the Australian federal government made the recession less worse than it might have been and produced positive GDP growth. This has everything backwards, although it's being swallowed whole by the financial press.

A rebound based on monetary inflation and government spending isn't a real rebound at all. It gives the appearance of normalcy and economic health through rising asset values and more transactions in the economy (which GDP itself measures). But unless there's a big pick up in private investment, the economy is not on any sounder long-term footing.

In fact, it's worse. The illusion of prosperity created by stimulus spending induces people into maintaining debt loads they might otherwise reduce. Consumption patterns which ought to change in order to put the household and corporate balance sheets back in working order aren't changed at all. And when the government stimulus is withdrawn later---as it must be before higher fiscal deficits lead to rising interest rates-the economy reverts back to its pre-stimulus levels of growth-only without the underlying issues of over consumption and too much debt having been addressed.

Or the short version: there is no easy way out of this mess. The government can't create wealth by borrowing money or taxing people and spread the lucre around to favoured groups at the expense of others. That's theft and it's immoral. But the real issue is that the whole economy needs to reduce leverage. The housing bubble has to pop. And the nation has to quit living above its means (we remember writing this about America five years ago).

How about some reader mail?

Hi Dan,

Gene A.

Not this first time we've heard this and won't be the last. We write about outliers and Black Swans. Those topics are controversial, which is why the mainstream media is afraid to express a real idea about them. What's more, getting people's attention in this economy is tough. Sorry you don't like the ads. But don't expect them to change.

For one, we have to pay the bills. As much as we like writing the DR, there's an entire publishing operation to support that provides research to paying subscribers. Secondly, we wouldn't describe any of our publications as "loopy get-rich quick schemes." We know how much time and research goes into each monthly report. We stand behind all the ads and have a hand in a fair a few of them to make sure they're telling the stories we think you can profit from. If you really don't like them, you can always just ignore them.

--Hi Dan

Aidan

--DR

John

Dan Denning
for The Daily Reckoning Australia

• China and its Trade
• Economy of China to Decelerate?
• The Iron Ore Pricing War Between China & Australia
• Anthony Bolton on China
• China, the Miracle Economy

"So, from now on, no exchanging dollars for gold for you either! Hahaha! You believed us when we guaranteed our promise about the value of the dollar in terms of gold, and then let us keep the gold at our house? Hahaha! Morons! So just come and try to get it, chumps!"

The problem was that the government was being bankrupted by maintaining the foolish Leftist stupidities of Johnson's "Great Society" and the sheer stupidity of the Vietnam war (among other governmental stupidities), and lots of dollars were being created by the Federal Reserve and multiplied by technology increasing the velocity of money through the banking system, resulting in a lot of inflation and a lot of dollars piling up overseas.

Fortunately, it was France making all the noise, and real Americans - who hate the French for their snotty attitudes - were smart enough to be alarmed, since the French knew that the buying power of the dollars that they held - and would be getting in the future - would all be losing valuable purchasing power. Naturally, they wanted to exercise their option to exchange the dollars for gold!

This was okay for a while, but pretty soon there was a torrent of gold leaving the country, causing Nixon to reveal just what kind of country does this kind of lowlife deal breaking.

Then Nixon said, "No more exchanging stupid paper dollars for real gold!" The reason Nixon was forced to act like a lying, thieving little creep is partly because he WAS a lying, thieving little creep, but mostly because he mirrored America perfectly since Congress allowed it, nobody at the Federal Reserve was hung, imprisoned or even received a stern lecture, and there were no street riots at the sheer shame of it all.

This is not about how I am glad that Roy Rogers and Hopalong Cassidy are dead so that they would not see the kind of embarrassing, black- hat, bad-boy bunch of dad-burn, sidewinding, backstabbing, ornery, polecat bushwhackers we have become, but to show you how good the French were in predicting the fall in the value of the dollar.

And for that we only have to look at the essay titled "The Day the Dollar Died - and the Day Gold was Reborn" by Bill Downey of technicalcommoditytrader.com, who has researched a handy comparison between then and now.

He compares "How Much things cost on Aug 15th, 1971" to what they cost today.

Dow Jones Industrial Average 890 or 25 oz. gold in 1971, versus 9,000 or 10 oz. gold today.

Average Cost of new house $25,250 or 721 oz. gold in 1971, versus 250,000 or 277 oz. gold today.

Average Income per year $10,600 or 302 oz. gold in 1971, versus $70,000 or 77 oz. gold today.

Average Monthly Rent $150 or 4.3 oz. of gold in 1971, versus $824 or 1 oz. of gold today.

Datsun 1200 Sports Coupe $1,866 or 53 oz. gold in 1971, versus $28,400 or 31 oz. gold today.

Naturally, I am looking over this little chart with some puzzlement, and I am thinking to myself, "It seems that there should be a message in there somewhere, but what?"

Fortunately, before I could think about it some more, and wonder some more about what the "message" was, and then get a headache from all the thinking and the frustrations of failure, and then decide to go out for a drink to clear my head, or maybe take an afternoon off to play a round of golf, both of which get me in trouble with my boss, Mr. Downey reveals it as, "Conclusion: If your money is dollars, you live in an inflationary world. If your money is denominated in gold, you live in a deflationary world."

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• An Edifice of Pure Economic Crapola
• Price of Silver Climbing to All Time High of US $1,012
• California Has Run Out of Money
• Don’t Pay Your Debt: A Page from the Fed’s Playbook
• Gold Standard: The Long-Run Value

Alas, he did not fly. Nor even float. He fell "like a stone," the paper reported.

Immortality was achieved, but not the way he had hoped. His stunt was captured by the new motion picture technology of the time. That silent film inspired the very popular Jackass videos, which show people engaged in reckless acts of mischief and mortality.

But we do not have to go to Youtube to enjoy the Jackass genre. We have only to read the news. All over the world the authorities are strapping on their absurd parachutes...and climbing to very high places. In Europe, banks borrowed 442 billion euros last month from the European Central Bank. Much of it is lent back to European governments. In America, stimulus funds are used to fix public toilets, as well as to repair Wall Street's balance sheets. Trillions of dollars have been put at risk in these adventures - $23 trillion in the United States alone. And yet, despite the most daring experiment in stimulus ever, by the end of June, the British economy was 5.6% smaller than it had been a year before, paralleling the decline that followed the crash of '29. As for the United States...we await the figures...

On the evidence, stimulus programs aren't working. In fact, where they are tried the most they work the least. For proof, we go to Stimulation Nation itself. From America last week came news that new house sales had finally turned up. They were up 11% in June, according to the papers. That was the monthly figure. According to the annual numbers, they were down 21% from the year before - at the second lowest since they began counting in 1963. And since the population is much bigger than it was 52 years ago, this was relatively the worst June in history for new house sales. And now that the economy is in a slump, the rate of new household formation has been cut in half. Faced with lower incomes and worsening jobs prospects, people are less eager to set up new households - reducing the demand for new houses.

Unemployment shows no sign of improving, either. The stimulus program was supposed to cap joblessness at 8%. Officially, the rate is now 9.5%. Economist David Rosenberg puts the real unemployment rate almost twice that high. And businesses are cutting jobs even faster than expected. Economist Arthur Okun suggested a rule of thumb for predicting unemployment levels in a downturn. But firms are not only laying off redundant workers; they are laying off workers who would normally be spared. What's more, those who are left are working the shortest weeks ever recorded.

In the past, workers were quick to move to where the jobs were. The Sun Belt traditionally bounced back first. But Florida, California, Arizona and Nevada have been flattened even more than the rest of the nation - by record foreclosures, government cutbacks and bankruptcies. Now, the jobless stay put...and stay unemployed.

Currently, the excess capacity in the United States is staggering - both in labor and capital. Capacity utilization is only 65%; in theory, output can increase 35% before any new capital investments are made.

Recovery? "Forget it," says Rosenberg.

Now that the facts are out of the way, we end our critique of stimulus...and turn to laugh at the stimulators. "Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back," wrote John Maynard Keynes. And now it is Keynes' voice they hear.

"We are all Keynesians now," said Richard Nixon as he strapped on a crash helmet.

Keynes probably got the idea of a counter-cyclical stimulus in Bible class. And a good idea it was. Simple...intuitively correct...practically demonstrated...and theoretically sound. But he and his followers still managed to screw it up.

First, Keynes' General Theory is no theory at all...at least not in the scientific sense. It can't be tested. The results aren't reproducible. Instead, it's merely an idea about how things should work, based on an Old Testament story.

Pharaoh had a dream. He dreamt he saw seven fat cows devoured by seven scrawny, misbegotten cows. He didn't know what the dream meant, so he called for a young Hebrew man who had interpreted dreams for his master. Joseph told Pharaoh that Egypt was to enjoy seven years of abundance followed by seven years of famine. He told him what he should do about it too. He should store all the grain he could from the fat years...so he could pass it out when the going got tough.

This is a story we all know. It is easy to tell and easy to understand. But modern economists twisted it as though it were an inflation statistic. They maintain that when the business cycle turns down, it's just like a drought. And they can counteract the effect of the drought by giving the economy stimulus - liquidity - from the public sector.

Trouble is, they missed the point completely. Do you recall any public official urging the public to stop spending so much in the bubble years? Do you remember any Treasury Secretary or Fed Chairman suggesting that the U.S. government run real budget surpluses in the fat years? Does any headline from any paper in the nation mention a storeroom in which grain or treasure was stored for the lean years? Not at all! Instead, the feds encouraged people to eat their grain! Governments ran deficits even during the bubble years, with the biggest deficit in history in 2008, just as the lean years began. Now they have no real grain to offer. So they turn to a reckless, disaster-defying stunt - passing out phony money, like sawdust muffins...

Future generations will watch the video and laugh until their stomachs hurt.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• US Federal Government Ran the Biggest Deficit in History
• Government Stimulus Programs Make Life Harder For Banks
• The Dead Weight Cost of the Stimulus
• Economists Agreed the Stimulus Was Working and the Recession Was Coming to an End
• Public Works Done Right

One thing smart people always do is to underestimate the power of foolishness. It is wild and reckless to stir up a race war. But that doesn't stop people from doing it. Any kind of war is a blow to reason and civilization. But that hasn't made war unpopular, even among the most
reasonable and civilized people on the planet.

It was within the lifetimes of many people reading this Daily Reckoning that the most advanced countries on earth began a war of annihilation. At the beginning of the 20th century, high culture and science were dominated by Germans. German musicians and composers...German poets and writers...German mathematicians, physicists, painters, philosophers - even the German economy was a world leader, second in output only to the United States of America.

Then, the Germans went off their heads - along with the Italians, the Russians, the Japanese...and many others.

But the Han have it right. The Uighurs are beasts from time to time. So are the Han...the Teutons...the Anglo-Saxons...and all the tribes on earth. Occasionally, for no apparent reason, the masks and restraints of civilization give way to mobs...and the old beast starts howling at the moon.

It happens in markets too. What is a bubble, if not a wild and reckless thing? A kind of madness? A mass illusion...a foolishness, in which people leave reason and civilization behind?

What if the United States had to pay its debt in gold?

In the old days, before the monetary reforms of the 20th century...notably, Richard Nixon's unilateral decision to renege on America's promise to pay its bills in gold...countries had to settle up with each other in the yellow metal. The system worked well; it was reliable; it prevented bubbles. Edward Chancellor explains:

"A country had to pay for its imports or foreign investments with money gained from a surplus on trade. If more money was sent abroad than had been earned through exports, then gold would be packed onto ships to discharge foreign creditors. A declining stock of bullion would induce the central bank to raise interest rates in order to attract gold from abroad. Rising rates would produce a credit contraction, unemployment and general economic misery. The typical nineteenth century was severe, but short-lived."

Then came the improvements. And the Great Depression. And now we are faced with another one.

Governments are fighting this one...just as they did the last one...but with much more money. The cost is in the trillions - most of it in the form of public debt. How will these debts be paid? We all expect that they will ultimately be eased by inflation - in full or in part. But suppose the feds had to pay up in real money?

Colleague Simone Wapler compared government debt to government gold. The United States has gold worth about $241 billion, she reports. Its official national debt is $11.5 trillion. That gives it a debt/gold ratio of 48 -
meaning; the feds have 48 times as much debt as gold.

Britain is even worse. Prime Minister, then Chancellor, Gordon Brown sold much of England's gold at the worse possible moment - about 10 years ago. This leaves the island with only $9 billion worth of gold compared to $1,274 billion of government debt - a ratio of 1 to 139. But Japan is the worst of all. It has $23 billion worth of gold and $7.3 trillion of government debt, for a ratio of 1 to 323. (Of course, Japan has vast holdings of dollars too!)

What nation has the best gold/debt ratio? Switzerland. It has only twice as much in government debt as it has in gold.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Mainstream Economists Congratulate Themselves
• Eurozone Drops GDP Bombs
• Rumours Swirl Over Chinese Equity Stake in BHP Billiton
• China Rises While United States Declines
• BHP Billiton, Rio Tinto and the American Civil War

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

"The dirty details:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

David Leonhardt, writing in the New York Times:

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

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

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

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

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

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

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

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

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

That's how capitalism is supposed to work.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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