Not that any of this week's news will change what we think is going on in the real economy. And what is that? Asset values bid up to record heights during the credit boom are deflating. This most seriously affects the value of bank collateral (commercial and residential real estate). But listed property trusts, infrastructure funds, and unlisted assets held by superannuation funds and state and local governments are also affected.

For example, today's Australian reports that the property sector alone has seen $51 billion in the value of its assets "wiped out" in the last twelve months. "After 10 years of 16 per cent annual growth, fuelled by offshore buying sprees and debt binges, the property industry's gross assets dropped from $420bn last year to $396bn this year, according to industry analyst Property Investment Research."

The "wipeout" in the sector was especially bad news for Babcock & Brown, Rubicon Asset Management, and Record Funds Management. These heavily leveraged firms didn't survive the steep rise in global borrowing costs. It didn't help that asset values began tumbling when the leveraged dried up.

There are still some big players in the listed property trust sector. These firms stand to lose even more if there is a second wave of deleveraging in the financial system. This list includes Westfield Group, with $56.4 billion in assets, Centro Properties ($28.4 billion in assets), Macquarie Group ($16 billion), and Stocklands ($14.7 billion).

Of course we're not suggesting that assets are worth nothing. But to the extent these assets are dependent on the growth and strength of consumer spending in the economy...well yeah, we'd be a bit worried. Wage deflation in the Western world is a given. This means that in real terms, the average consumer is going to have less and less discretionary income to spend each year. Unless he can make up the difference with credit, we'd suggest it's bad news for many of the retailers that lease space from the listed property titans.

But don't forget the unlisted sector! AMP Capital Investors is the biggest asset manager in the group and also the largest property securities funds manager. You see, Australians don't just bet on higher house prices in the residential mortgage market. They've been betting on higher property prices all throughout the system with many unlisted property-linked securities. It means that more destruction of bank collateral could have a much larger affect on a lot of listed and unlisted investments than most people imagine.

To counter this wave of debt deflation, at least in America, is the huge growth in bank reserves and low interest rates. But here in Australia, it looks like interest rates may be headed up, not down. That won't be good news for anyone who is trying to refinance loans to support falling property values.

So what will do well in the next six months? Keep in mind that results this week from Rio Tinto and Centennial Coal are likely to show the volatility of earnings for commodities that are not continuous prices (thermal coal, coking coal, and iron ore). Those are still pretty bullish markets - if you're banking on a Chinese century. But what about energy?

You could make the argument that U.S.-dollar sensitive energy prices are the most likely to beat inflation. It's not a sure bet, of course. If the global economy is sluggish, energy prices won't soar. And U.S. dollar weakness is generally bullish for all commodities.

But for the record, we think energy shares are the best inflation beaters. Britain's Sunday Telegraph reports that Shell is chasing Arrow Energy's coal-seam-gas assets. Shell already owns 30% of Arrow's Australian assets. But coal-seam-gas has emerged as complimentary/competitive fuel source to Liquid Natural Gas. Shell wants more.

And beyond liquid fuel, you have energy stored in chemicals. Namely we're talking about lithium ion and nickel metal hydride batteries. Both, along with some zinc technologies, are bidding to be the chief battery type for the electric and plug-in-hybrid car industries. There a handful of intriguing plays listed in the Aussie share market in this space. It's a story we're covering over at Diggers and Drillers.

Finally for Monday, today's Sydney Morning Herald is reporting that, "Six OF the country's nine banks have tightened the amount of money they are prepared to lend to first-home buyers in a response to claims that the Federal Government's cash handouts to the housing market are causing a bubble in prices."

Tough spot for the banks. Do you lend to marginal buyers to prop up demand and take the risk of increased non-performing loans? Or do you tighten up lending standards and reduce average loan sizes, at the risk of leading to wider losses in collateral values? Sounds like a no-win situation, doesn't it?

Dan Denning
for The Daily Reckoning Australia

• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
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• How to Buy Crude Oil for US$2 a Barrel
• The World Needs More Richard Bransons
• Australian Investment: Shares or Property?

Commonwealth Bank reported its full-year results to the ASX earlier this morning. The highlight (or lowlight) was that second-half profit fell by 16% to $4.72 billion compared to the previous six-month period. This happened despite a 19% surge in home lending to $257 billion and a smaller 6% growth in business loans to $135 billion.

Does it look like the bank is doubling down its bet on Aussie houses?

For the full year, if you exclude the $612 million after-tax profit on the acquisition of BankWest, CBA's net profit after tax was down 9%. Cash earnings fell by 7%. CBA also took a $2.94 billion impairment charge for bad loans. It took a loss on notes in failed day-care provider ABC Learning Centres and noted, "Home loan arrears over 90 days and personal lending arrears have increased on the prior year with deterioration in the second half."

Trade the banks if you'd like. In fact, that's what Gabriel says you ought to do - trade the trends. But buying and holding may be a bad strategy if bank earnings and cash flows remain so unpredictable. And we reckon they WILL remain unpredictable.

If we're right, households have just begun reducing their debt loads. It will take years for the leverage in the system to be wound down. If you're buying bank stocks you're assuming credit and debt growth will resume once this recession is over. That's a big assumption. And probably stupid.

By the way, CBA also said - presumably because cash earnings are down - that it's cutting its second half dividend by 25% to $1.15 per share. That puts the full-year dividend at $2.28 per share.

It's not shabby. But remember, you still have your capital at risk. And as Kris Sayce has shown in his debut issue of the Australian Wealth Gameplan, there are other businesses in Australia with strong and regular cash flows that also pay you regular dividend income - arguably with a lot less risk to your capital.

In case you think we're just bashing Aussie banks, we'd suggest that the profit outlook for U.S. banks sucks too. U.S. stocks fell overnight. One big reason why is that JP Morgan came out with a shiny new report that said losses at bond insurer MBIA may wipe out capital at the firm. MBIA's shares fell by 13%.

Wait! Haven't we seen this film before? Is it possible that the recovery in earnings everyone used to justify the recent rally was really just a bunch of second quarter cost cutting, and NOT a fundamental improvement in business conditions? Is it possible, as John Hussman suggests below, that the fundamentals that supported the previous bubble have vanished, making it more likely that corporate cash flows are headed lower for years to come?

Hold that thought. One of the factors that led to an increase in second quarter earnings was cost cutting. And officially, cost cutting - when it entails firing people - improves productivity. It does not, however, increase wealth.

There are two kinds of productivity. The first kind is where you produce more because you have new skills and you can do your job faster and better than before and produce something better. Your personal output rises and the aggregate output of the economy rises. That's the good kind of productivity. Everyone wins.

The other kind of productivity is where you end up doing the job of three people because two others have been fired. That is the bad kind of productivity. Your output rises. But your increased work load doesn't mean the economy is using resources more efficiently or producing more goods and services per person. You are also probably at least three times more miserable, stressed, and unhappy...having more than three martini lunches or whiskey breakfasts.

So what do you make of the fact that U.S. productivity grew by 6.4% in the second quarter according to the Bureau of Labour Statistics? It was definitely the second kind of productivity growth. Second quarter output actually fell by 1.7% according to the BLS. But total hours worked fell by 7.6%, raising the output per worker by the most since 2003.

Alan Greenspan started yammering about productivity growth in 2003, when it looked like the U.S had leveraged the tech boom into a huge structural increase in productivity. The argument at the time was that computers and modern telecommunications had led to a huge surge in productivity.

The jury is still out on that. There are some industries that would simply not exist (or exist at the same level) without computers and the Internet (ours being one of them). But whether or not modern technology has made people more or less productive is an open question. Does Facebook make people more productive? Does Twitter?

It also depends on what kind of output you're talking about. If by productive you mean, "make more stuff" or you mean "generate more work." Information technology has generated huge volumes of work - information, trading, transactions - in the financial sector. But is the economy any wealthier for it? Has the capital stock of the nation increased?

Say's Law says that supply creates its own demand. What Jean Baptiste meant by that is that you create your own purchasing power and future demand by producing goods that you can sell. Those goods generate your income and that income becomes the source of your consumption. But in that old-fashioned way of thinking about things, all economic prosperity comes from producing things of value and selling them.

We live in the dying days of an era where people think wealth comes from consumption. Why else would the government encourage consumption without production via cash hand outs? It reckons this money will stimulate production by stimulating demand. But demand comes from people having money to spend to begin with. And they can only do this if the economy and the job market are geared toward producing wealth, not spending it.

Speaking of producing wealth, Chinese firms have been busy this week chasing Aussie real assets. State-controlled Yanzhou Coal has made a $3.5 billion bid for Felix Resources (ASX:FLX). This would be China's biggest Aussie acquisition to date. It values Felix at $18 per share, which is about 10% above the closing price before Felix went into a trading halt on the announcement.

And in today's Age, Barry Fitzgerald reports that Hebei Mining - the State-owned mining company of China's Hebei province - has taken a 14.9% stake in unlisted Western Australia uranium explorer Raisama. Raisama issued Hebei 4.5 million new shares and sold it 2.5 million existing shares at 25 cents a piece.

Raisama also said that, "''The Hebei provincial Government currently has plans to build at least three nuclear reactors and is selectively securing strategic interests in uranium exploration companies internationally that it believes have the best potential to meet the province's growing need for uranium."

Despite (or because of) all the controversy over the arrest of and bribery charges leveled at Rio Tinto iron ore executives in China, Chinese firms are still busy buying Aussie resource real estate. This is happening for a couple of reasons. China has heaps of U.S. dollars it gained in trade that it would like to get rid of before America inflates the value of them away. China also has long-term resource needs.

But since we've covered both those subjects before, let's address a different part of this equation: the valuation. Is China paying too much, too little, or just enough for its stake in Aussie resource firms?

Not all assets are created equal, we mentioned yesterday. For example, Commonwealth Bank's chief assets are its loans to customers and its deposits. But the deposits are callable by customers and the loans are only worth what they're worth if people can pay them back.

With resource companies, the main asset on the balance sheet is a mine, an ore body, or a lease or a permit to drill and/or explore a prospect. Sure, mining companies are capital intensive and this capital equipment shows up (in depreciating fashion) on the balance sheet, along with cash.

But the chief asset of any resource company is the resource it hopes to produce. Just what that asset is worth depends on a number of factors. One big factor is the quality and quantity of the resource. You want to know whether it's a reserve - a clearly defined asset with reasonable projections about how much can be produced economically, given today's commodity prices - or a resource (a less defined estimate of how much of a given commodity might be underground).

Other factors are the capital spending required to produce the asset (including mine constructing and ore processing, in some cases) and the operating expenditure. For example open pit mines are cheaper to build and operate than underground mines, and projects far away from infrastructure (rail, port, roads) have much higher operating costs. Labour and raw materials are also variable costs that tend to rise in a commodity boom, as we all found out in 2007.

The great variable in all this is the price of the underlying commodity itself. That changes based on both supply (other producers) and demand (economic growth, or the variables that drive individual commodity prices, including investment demand and speculation). In the traditional commodity cycle, high prices attract more producers and low prices drive out all but the lowest-cost producers with the lowest cost ore bodies.

Judging by this week's activity, Chinese firms are happy to take a stake in existing producers with clearly defined reserves and resources. But they're also happy to pony up the capital and fund explorers who have big hopes but no production and no clearly defined asset. So what does that tell you?

Maybe China is speculating on real assets the way Australians speculate on house prices and Americans speculate on stock prices. And what does THAT tell you?

For now, it tells us that Aussie assets - both equities and real assets in the ground - are in demand. Frankly it's all sounding bullish isn't it? Will Chinese demand for Australian resources diminish if the People's Bank of China tightens monetary policy to prevent bubbles in property and the share market? More on that subject tomorrow, including the dreaded Fibonacci retracement on the S&P 500.

Dan Denning
for The Daily Reckoning Australia

• Wesfarmers (ASX:WES) Increases Revenues But Not Earnings With Coles
• Banks or BHP?
• You Can Never Be Sure How Fabricated Income and Earnings Are These Days
• CRB Commodities Index Has Largest Decline in 50 Years
• Oil Was Down and the Banks Were Up

It's not exactly a ringing endorsement of central bank policies. But it does indicate that in at least some credit markets, there might be money to borrow if you can talk a bank into lending it to you. However, as Dr. Marc Faber told the Agora Wealth Symposium yesterday, "You cannot create prosperity through money printing and debt growth."

It's a fair point, isn't it? You don't get rich by spending money. Wealth cannot be achieved through a systematic attempt to impoverish the middle class through higher debt levels, lower asset values, higher taxes, and lower real wages.

That all sounds like common sense. So why are so few policy makers using their head? The people who hope the global economy can be revived through a resumption of credit growth seem to forget that it was massive credit growth that created the problem (massive global imbalances, huge debt levels, and mal-investments) in the first place. That problem now resides on bank balance sheets in the form of bad collateral and on household balance sheets in the form of credit card debt and a mortgage.

This sets up an interesting problem. How can you have inflation if impaired bank assets prevent the resumption of bank lending? Our old friend Dan Ferris says this about the issue, "Mass destruction of bank collateral certainly reduces lending capacity. Since our banking system is where the bulk of our money is created, deflation seems a rational expectation...Except," Dan adds, "that the redwood seeds in the money-creation forest - excess bank reserves - have grown approximately 4,500% lately, to around $900 billion."

"Multiply those reserves by 30 or so, as the banking system would over time, and you get more than double the entire GDP of the United States. But as long as the banking/lending apparatus is broken, it's hard for the system to multiply new money into existence via loans and deposits."

Dan makes some great points. Most money creation in the economy does come from the banks. Through the wonders of fractional reserve banking, the banks can turn each new dollar of deposits into ten dollars of new lending...and then lend on each of those ten dollars when they make their way back to the banks. This is why banks are the traditional engine of money supply growth in an economy, and thus the proximate cause of inflation (an increase in the money supply).

But if banks are still nervous about asset quality, they are much less likely to rev up the money creation engine with new lending. In fact they're likely to do the opposite and stockpile cash. That's what Dan has pointed out, showing that excess reserves held by banks at the Fed are rather large.

And if banks don't have cash to stockpile against further losses, they'll just go out and raise some. That's exactly what NAB has done. "National Australia Bank Ltd., the nation's biggest lender by assets, said it will raise A$2.75 billion selling shares to help weather rising bad loans and finance potential acquisitions," reports Malcolm Scott at Bloomberg yesterday.

This is part of "Operation balance sheet repair through the equity markets." NAB is not alone in using secondary offerings on the stock market to raise capital this year. Secondary offerings in the Australian stock market raised nearly $90 billion in fiscal year 2009. That was up 74% from the year before. Meanwhile, initial offerings (IPOs) raised just under $2 billion for FY 2009, an 83% decline from the year before (which itself was horrid).

That tells you there was hardly any new capital available for new businesses. Only 45 companies went public last year, compared to 236 the year before. That shows you how tight capital really has been. Of course, even listed companies have had trouble raising money in the secondary market.

So what does it all mean? It means Aussie investors (institutions and households) have provided Aussie companies with a capital cushion during the worst of the credit crisis. Will it be enough? What will the return on the capital be? Is it throwing good money after bad?

Those are all questions you have to look at on a stock by stock basis. Some companies are more efficient with capital than others. And a company that delivers a high return on net tangible assets without having large, recurrent capital expenditures is probably a company worth owning, or at least looking at-especially in this era where capital (and real capitalists, people who know how to put it to work) are so rare.

This, by the way, is why we're still so bearish on financials. The capital infusions on to bank balance sheets are there merely to offset the decline in the value of bank collateral (mostly residential and commercial real estate, as Dan says, but also all sorts of other securitised loans). But when a company like Santos raises $1.2 billion in new capital, you can be pretty sure it's not to offset losses from high-risk mortgage lending.

By the way, speaking of Santos and LNG, did you see that China's biggest offshore oil and gas producer, the China National Offshore Oil Co. (or CNOOC) is going to drill three wells in the Northern Bonaparte Basin and look for natural gas? Yesterday's West Australian Business News reported that, "The guaranteed first stage program, worth $80.8 million, will include up to five wells and 400 square kilometres in 3-D seismic work...The commencement of drilling will be a major milestone for CNOOC, which has been leading China's global push to secure long-term energy supplies."

Back to traditional capital for a moment. Does the fact that Aussie firms have raised so much equity capital mean the nation is not nearly as dependent on imported capital as we have feared in the past? The jury is still out on that one.

"Foreign banks are refining their lending activities in Australia rather than returning to their home bases," reports yesterday's Australian Financial Review. This means foreign lenders haven't abandoned Australia entirely. "But the funding pressures on Australian companies remain intense. Data show an 80% fall in the amount of syndicated loans in Australia in the first six months of the year."

Syndicated loans are loans where one or two banks organise an overall loan package in which multiple foreign banks are lenders. This reduces the risk (theoretically) of any one lender losing a lot on a loan. According to the AFR, "Global syndicated lending totalled $947 billion in the six months to June 30, a 49.2% fall from the year-earlier period. Australian loan volume fell an even steeper 80% to US$9.7 billion."

We realise that this is a lot of scrutiny to pay the capital structure of a company. But that matters now as much as it ever has to individual investors, and probably more. A company (like a bank or non-traditional mortgage lender) whose assets are mostly made up of iffy loans can quickly see its equity wiped out on high loan losses. This wipes out common shareholders.

Also, as we've seen, companies with huge refinancing needs can hit the wall quickly if capital markets are not keen to reinvest in the business (and they might not be if the business is an inefficient user of capital). That raises the question of how the banking industry itself is allocating capital in the real economy, and where a nation's accumulated savings are being productively invested (or unproductively squandered).

But let's not go into national capital allocation strategies today. Let's focus on two potential opportunities in this idea for Aussie investors. The first is that Aussie banks fill the lending gap and are able to do so at very favourable rates to themselves (and shareholders, via a rebound in dividends that were cut earlier this year). Their share of the syndicated loan market could increase if there is less foreign competition (although Chinese banks seem eager to loan some of their accumulated capital to Aussie businesses and consumers).

The second opportunity is something Kris Sayce has been looking at in his new publication, Australian Wealth Gameplan. We're talking about the growing universe of fixed income and hybrid securities listed on the ASX-or really anything that produces more income for you as an investor. Of course the world of high-yield fixed interest investments is not exactly a risk-free place these days (property, managed investment schemes etc).

But the retail bond market-where you can buy a corporate or government bond as easy as you can buy a share of BHP or Rio Tinto-is developing quickly in Australia. Both AMP and Tabcorp issued bonds in April targeted to the retail investors. And if there is liquidity to be found among Australian investors looking for risk-free income, you can bet Australian companies will find a way to tap that liquidity, even if it means doing something new like selling bonds instead of new shares (which dilute existing shareholders).

Of course there is no such thing as "risk-free income." Government bonds have that reputation (increasingly undeservedly). That's why the ASX is working with the Australian Office of Financial Management to list government bonds on the local exchange. The government would love to tap retail funds in order to finance its deficits (which are large and growing).

But you could probably do better-at least in terms of yield AND capital gains-looking at corporate bonds. The nice thing about being a bond holder is that you rank the highest in a company's capital structure. That means if the company does go bankrupt, you get paid first because you are a secured lender (unless you are GM or Chrysler bond-holder and you get strong-armed and ripped off by a socialist American president).

You could do even better buying distressed bonds. You look for companies that everyone thinks may go bankrupt. Then you just have to do a little balance sheet analysis. If the assets exceed the liabilities, you can almost guarantee that you'll make money. At the very worst, as a secured creditor, you get your money back in a liquidation of the firm's assets.

Or, if Christian Noyer is right and global credit conditions improve, you'd get a capital gain (if you bought the distressed bond at a discount to par) AND whatever yield the bond has (typically high the higher perception of risk). And that would be a mighty fine trade if that's your game.

We'll keep you posted on what Kris finds in the fixed income world. His solution is a lot simpler than the strategy we outlined above. Australian blue-chips, for whatever reason, have tended to pay higher average yields than their American counterparts. In fact the dividend yield on the S&P/ASX 200 tends to exceed the yield on the S&P 500.

That may reflect Australia's traditional status as an importer of capital, and the need to offer higher yields for what are perceived as riskier assets. But Kris has already found one blue-chip with a great yield and a great return on net tangible assets (capital efficiency).

The good news is that we think the market should favour investors who can look at the capital structure of Aussie firms and capture yield from the ones that are not burdened by non- or under-performing loans. The better news is that Kris is doing the looking so you don't have to!

Mind you we're not implying that Noyer is right and everything is fine. Hardly! We think banks will continue to play it safe (and quake in their boots). Aussie banks continue to hold around $2 billion on reserve at the RBA. This is down from the double-digit overnight figures in the panic days of last year. But it still shows some reluctance to unleash a new credit boom via bank lending (or a lack of new, worth projects to lend to).

But we should probably be very thankful that Aussie banks haven't gone whole hog back into the lending market. Though the RBA says inflation is tame, the amount of monetary reserves in the global financial system are just the sort of thing that could lead to a wildfire of inflation, including here in Australia. It's just what the Fed wants to assure us it will NOT let happen. But the Fed may not be able to control the actions of the most profligate spenders of all: national governments.

We believe that in the absence of new bank lending to promote economic growth, governments are going to ramp up deficit spending even more this year and next. As Dr. Faber said in Vancouver, "I believe next year's economy will face even larger deficits. Their deficit is attempting to stimulate credit growth. Unless real credit growth returns, they will have to put more and more money into the system to maintain the status quo. All polices target consumption. That is a mistake."

So what's this mean for the market? This is just one of the questions we're taking up at next week's debt summit in Melbourne. As for the U.S. Faber says, "The S&P 500 will not recover to 2007 highs. At the peak, 44% of the S&P was the financial sector. That is gone... not coming back."

Does that mean the recovery in Aussie financial stocks is a fake out move too? More on that tomorrow. But just keep this in mind the meantime...this debt crisis doesn't mean the world will end. It just means there's going to be a big change in who owns global asset. That ownership is being transferred from debtors to creditors. That's what worries us here in Australia...

Dan Denning
for The Daily Reckoning Australia

• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• U.S. Fed Now Accepts Credit Card Debt as Collateral
• RBA Rate Cut Does Little to Unlock Credit Market
• Banks or BHP?

It's probably not fair to leave common stocks out of the question. After all, the ASX is on a 5-day winning streak and some analysts are now confident enough to say the bear is dead. No one is exactly predicting a return to the boom-time years of 2003 and 2008. But with oil up, gold up, shares up, property up, commodities up, and bonds up, it does feel a bit like 2003, when everything inflated thanks to low interest rates across the globe.

The Australian share market news is dominated by production figures this week. Back-from-the dead Oz Minerals reported that productionfrom its gold and copper mine at Prominent Hill will meet guidance. Last week Rio Tinto reported an 8% increase in iron ore production, but weaker production for aluminium, alumina, and bauxite.

We'll get to the sector that really interests - energy - in just a moment. But to amplify a point made yesterday - keep in mind that the rally in Aussie resource stocks may be fuelled by a lending bubble in China that's going to pop. That means resource demand and underlying commodity prices may be a lot more volatile in the years ahead, as Chinese regulators struggle with the conflicting goals of full employment and containing inflationary bubbles.

"(We) must control the risk of real estate loans," said Liu Mingkang, the head of the China Banking Regulatory Commission, according to CNBC. He says Chinese banks must take better measures to evaluate the creditworthiness of borrowers. Liu said, "In the first half of the year, our country's banking loans expanded rapidly and helped play an important role in stabilizing the economy, but the loans growth has led to accumulated risks also increasing."

A real estate bubble in China would undoubtedly lead to inflated demand for construction materials in the commercial and residential real estate sector. But let's assume the China lending bubble doesn't pop this week. And let's assume the value of Aussie shares is driven by underlying demand from China that IS sustainable and super cyclical. On that basis, what' worth a look right now in the share market? How about energy.

For starters, there's today's news that Energy Resources Australia has reported unaudited profits that are triple what it expected. The $120 million half-year profit comes from much higher than expected uranium oxide productions and a 27% increase in uranium prices since the March low of around US$40.

The uranium spot price is coming off a low after a big correction. But as we've covered in Diggers and Drillers, the demand for nuclear fuel from global utilities is on the rise. Australia - with over 30% of the world's proven uranium reserves - is in the pole position (side by side with Kazakhstan, arguably) to provide the world with what it needs.

That will only happen if the uranium mining industry really takes off. And maybe that's starting to happen. Last week Federal Environment minister Peter Garrett approved what will become Australia's fourth major uranium mine at Four Mile in South Australia. Four Mile is located about 550km north of Adelaide. It's owned 75% by U.S.-based Heathgate and 25% by locally listed Alliance Resources (which zoomed up on, and even slightly before, the approval was announced).

"Production is set to begin early next year at what will be the world's 10th-largest uranium mine," according to Barry Fitzgerald in the Sydney Morning Herald. "Its predicted annual haul of 1400 tonnes would be worth about $260 million at current contract prices and will increase annual production of the radioactive material in Australia by 14 per cent to 11,400 tonnes."

And there could be more on the way. "Queensland mining 'inevitable'," leads a story by Paul Robinson over at the ABC today." "Just as there's going to be uranium mining on an increasing basis in Western Australia, South Australia and the Northern Territory, we'll see uranium mining in Queensland in due course," says Federal Resources Minister Martin Ferguson.

"Mr Ferguson has told a Resources Conference in central Queensland, uranium mining is no different to developing coal or liquefied natural gas. 'It's about supplying the energy needs of other countries...We are energy rich, we do not need nuclear power, our responsibility is to mine uranium with safe hands and to guarantee that our uranium is used by countries that are only prepared to guarantee that it is used with safe hands."

We're not sure why Australia couldn't benefit from nuclear power too. But the Minister is right that between coal, LNG, and uranium, Australia presents investors with a great portfolio of energy choices. And that's not including traditional oil and gas explorers and producers.

Two more points about energy. First, the trading in shares is going to be volatile. That makes buying and holding a nerve-wracking strategy. The global economy is in transition. And with China and America wrestling over the bigger contribution to global growth - and overall resource demand - there's going to be a lot of unpredictability to both resource prices and demand. The shares will see saw.

That means investors may have to look at more actively managing their positions in resource shares. This is not to suggest that we should all be market timers now. But you'll want to have a strategy for dealing with volatility that allows you to lock in gains on rising share prices, but also buffers you from these big periodic falls that we expect to get as markets - and indeed the whole global economy - make the transition to a new normal.

The second issue on energy is that it may replace bulk commodities like coal and iron ore as Australia's largest export industry. Here we're talking about conventional off-shore LNG production AND unconventional coal-seam-gas LNG production. The unconventional LNG industry is admittedly a much newer (and we'd argue, riskier) industry that iron ore production. But that's what makes it such an alluring investment opportunity.

If you want to know what the oil majors think of the industry, keep an eye on Santos this week. In yesterday's Australian Financial Review, Paul Garvey reports that Santos could be a few days away from offloading a bunch of undeveloped gas fields in the Bonaparte Basin. Those fields could fetch the company nearly $500 million, according to Garvey.

But if you're interested in the kind of transactions that might move the company's share price, it's Santos' 60% stake in the coal-seam-gas fed Gladstone project that may start to attract cashed-up takeover suitors. Garvey reports that, "A series of standstill agreements preventing third parties from launching hostile takeover bids for Santos will expire in August and September."

Santos has a 17.7% interest in Exxon-Mobil and Oil Search's Papua New Guinea LNG project. Garvey says that project, "would be attractive to many energy companies, given its status as the most advanced LNG project now on the relatively cluttered drawing board in the region."

It IS a cluttered drawing aboard. That means there are going to be a lot of losers and a few big winners. Between the more traditional LNG, oil, and gas firms we're looking at in Diggers and Drillers, and the unconventional players in the Queensland CSG market that Kris Sayce is active with at the Australian Small Cap Investigator, there are a lot of intriguing firms to choose from.

Hopefully we've got it right that energy shares are the best way to invest in energy as an asset class. Of course shares are still shares. But one of the reasons we like Australian energy shares so much is that energy itself has become a kind of global capital - gradually replacing the worthless fiat trash pumped out in increasing volumes by governments. More on government debt as an asset class tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Uranium: A Carbon-friendly Substitute for Coal
• Energy Debate in Australia Needs to Get Serious
• Big-picture Case for Energy Stocks is Pretty Bullish
• Australian Iron Ore Shares on China’s Menu
• LNG – The Energy Play for 2009

Hold that thought. Her recommendation preceded Goldman's actual announcement on Tuesday that second quarter net earnings were up 65% to $3.44 billion. The company, like Wall Street's very own chosen-one-boy-wizard, has once again waved its magic wand and produced something remarkable. So let's remark on it...

The composition of its net revenues was a revelation. And as we reported in today's edition of Money Morning (where we are guest editing for Kris Sayce and also covering the Rio Tinto/China saga), Goldman's second quarter performance belongs to a bygone era of swashbuckling financial capitalism when interest rates were low and huge money flows made trading price movements in asset classes a full-time job.

Why do we say that? Goldman reported $13.76 billion in net revenues for the quarter. But 78% of those came from its "Trading and Principal Investments" group. That was a 93% improvement over the second quarter of 2008 and a 51% improvement over the first quarter of this year.

And yet again, the "black box" unit of "Fixed Income, Currencies, and Commodities" was the chief bread winner within the Trading group. It delivered $6.8 billion in net revenues, or 63% of the Trading group's revenues and 50% of total net revenues for the entire firm.

Investment banking-what Goldman used to do-actually experienced a 15% decline in year-over-year quarterly revenues. And the "Asset Management" business also saw a 28% decline in quarterly revenues compared to the same time last year.

We relay these things not to bury Goldman. Nor to praise it. But just to put it in perspective and ask whether the performance of this company-once you understand it from the inside out-is the sort of thing that should give you confidence about stocks now. Or, to the contrary, whether Goldman's performance is aberrant.

What did Meredith Whitney say about the matter? "Our more bullish outlook on Goldman Sachs shares," Whitney wrote, "is deeply rooted in our sustained bearish stance on the U.S. economy and the state of U.S. financials at large. Specifically, we expect a tsunami of debt issuance from federal/sovereign, state and local governments to fund woefully underfunded budget gaps."

"In addition, we expect corporate debt issuance to be at least 60% as strong as peak cycle levels, reflecting sizable debt maturity rolls. What's more, given fewer players in the market, not only is GS benefiting from market share gains on these products, but more widely in the derivatives products."

Whitney is bullish on Goldman because Goldman is good at trading its own book. But what's good for Goldman is probably not the same as what's good for everyone else. Real national wealth is not built on financial transactions. It's built on increases in productive that lead to rising wages and a growing capital stock. You might measure it on capital per worker. But however you measured it, it wouldn't have much to do with how good fixed income trading profits were.

By the way, did you see this the other day from the Financial Times: "Executives at Goldman Sachs sold almost $700m worth of stock following the collapse of Lehman Brothers last September, according to filings with the Securities and Exchange Commission." That sounds like a good trade.

One more note on the 4th branch of the American government. Bloomberg reports that Goldman may, "Lose its investment in a proprietary trading code and millions of dollars from increased competition if software allegedly stolen by a former employee gets into the wrong hands." Uh oh.

Last week in Manhattan, Assistant U.S. Attorney Joseph Facciponti revealed that ex-Goldman Sachs computer programmer Sergey Aleynikov has been charged with stealing Goldman's proprietary trading software. Aleynikov was arrested after he arrived at the airport in Newark, New Jersey.

The wrong hands?

Facciponti told the judge in the hearing that, "The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways...The copy in Germany is still out there, and we at this time do not know who else has access to it."

Is there a fair (legal) way to manipulate the market? If the software can be used to manipulate the market...and Goldman knew how to use the software...has the prosecutor unintentionally revealed some of Goldman's magic secrets? Or is he suggesting that other traders using the software can beat Goldman at its own game now that they know what rules the bank uses? We'll let you decide...

Dan Denning
for The Daily Reckoning Australia

• Warren Buffett is Buying Four Percent of Goldman Sachs
• Rising in Defense of Goldman Sachs
• Citi Reports $4.69 Billion in Fixed Income Trading
• Traders Sell Bank Stocks Due to Goldman Sachs Surprise
• JPMorgan and Goldman Sachs Making Billions in Profits

But how much more insight do we really need? We know the world is in the early stages of recovering from the greatest debt binge of all time. The central bankers are trying to keep the party going and prevent debt deflation. But the accumulated liabilities from the boom have to be written down or written off. Balance sheets must be rebalanced.

And we also know that markets are giving way to politics. The free market is waning. Government run markets, on the other hand, are waxing.

For example, it appears China is beginning to throw its considerable economic weight around. It's doing so in a tentative, experimental manner, not sure if it will offend but not seeming to care all that much. And why should it? The world is perfectly happy to do business with the largest emerging market of the next fifty years. Other issues-human rights, the environment, and the Rule of Law-are secondary.

It should be interesting to watch. If economic Empires were like teenagers, they'd be temperamental, volatile, and inscrutable. And so China-which to be fair is a venerable 5,000 year old culture-is entering its economic adolescence. Proud, confident, and slightly unpredictable.

For instance, is China trying to put Australia in its place by arresting Rio Tinto executive Stern Hu? Is this a not-so-veiled message that if Australia wants to benefit from China's industrial growth and stimulus pending, it had better be more compliant on things like, oh...say...iron ore pricing? Is Australia just now discovering that the new economic order comes with certain terms and conditions that are not negotiable?

And here's the really interesting question: If China is flexing its economic muscle, can it simply change the rules of global capitalism? China's market is large. Its savings are legendary. And the Western model of capitalism doesn't have a lot of moral authority and the moment. So will businesses be willing to do business in China, on Chinese terms, at the risk of landing their executives or workers in jail if they run afoul of ambiguously defined laws?

From a Chinese perspective-and we're only imagining here-it must be a bit too much to be lectured by anyone in the West on the Rule of Law or corporate ethics. After all, there's been plenty of Law breaking/flouting/changing in capitalist economies over the last few years. Does China's government intervene, intimidate, and manipulate any less than governments in America, Britain, France, Germany , and Russia?

The fact that we're even asking that question-unless it's a really dumb question-is not good for markets. It means that in currency matters, business matters, regulatory matters, and tax matters, investors have less and less certainty about the environment they're operating in.

Not that investors ever have total certainty. But the more variable and unpredictable (and capricious) the action of the State is, the more you can expect investors to lay up their stores in cash and sit on the sidelines. When you can't trust a currency or a sovereign bond...well then you're probably going to become very conservative about your future capital spending (and borrowing). All of which argues for either a second dip to the American (global) recession or anemic economic growth.

And then there was this bit of dollar subterfuge from the G-8 summit in Italy. "We should have a better system for reserve currency issuance and regulation so that we can maintain relative stability of major reserve currencies' exchange rates and promote a diversified and rational international reserve currency system," said Chinese State Councilor Dai Bingguo, according to today's Age.

How about that? China has 70% of its foreign currency reserves in U.S. dollars. It's walking a fine line. It would clearly like to rattle its currency saber in order to keep American deficit spending (and potential dollar devaluation) from threatening the value of those investments. But by repeatedly brining up the dollar's weaknesses, it does the very thing it wants to avoid; threatening the value of its dollar-based investments.

Free markets-one simple. Now complicated.

French President Nickolas Sarkozy tried to defuse the situation, but he only managed to sound like a moron. "These are complex subjects where positions have to evolve, but we can't remain based on a single currency," he said.

Then, proving that politicians knows more about dating leggy models than running an economy economics, he added, "We have to ask ourselves: Shouldn't a politically multi-polar world correspond to an economically multi-monetary world?"

If the Lion is the King of the Jungle, should he not also be King of England?

You can argue about where political power comes from. Some say trade. Some say sound institutions governed by the Rule of Law. Some say the barrel of a gun. For example, a nation can have a small economy. But with a small nuclear arsenal, it's going to punch above its weight geopolitically.

But economic power is not based on exclusively on coercion or the ability to intimidate your trading partners/strategic rivals. A "multi-monetary" world would be fine by us if it meant there was a free market in money. You would be free to use whatever money suited you best, and you would judge that money on its stability and its utility.

Yet as we begin the week, it's becoming plain to see that there's no such thing as a "multi-monetary" world right now. It's really a "bi-monetary" world. There is government printed (fiat) money-backed by nothing except the economic potential of the economy from which it comes (or the coercive power of the State which issues it). And there is free market money.

Free market money-at least in a world rife with mistrust about government money-is going to be gold and silver. In a geopolitically influenced market, a bi-metallic view on money may turn out to be the biggest winner.

And for what it's worth, we believe the larger cost of the credit bubble-in addition to the trillions in household wealth wiped out and trillions more in misallocated capital-is how far from its traditional roots Western capitalism has strayed. When people are free, when rules are clear and fair, when money is sound, and when private property is respected and money is not confiscated by the State, political liberty and economic liberty thrive side by side. Indeed, one is not possible without the other. More on the subject this week.

Dan Denning
for The Daily Reckoning Australia

• Nobody Appreciates Laissez-Faire Capitalism
• China Will Rule the Business World While America Finds Itself Heavily in Debt
• HOORAH FOR CAPITALISM!
• The War On Capitalism Continues
• Free Market Capitalism, The God That Failed

And now back to the financial markets....

Go you little Aussie mortgage bubble! The value of new mortgages grew in May by 2.2%, according to the Australian Bureau of Statistics. For the month, investors boosted their demand for new mortgages at a faster clip than people who intend to live in the house (owner occupiers). That doesn't sound like a bubble at all does it?

Two other items of note in yesterday's housing numbers. The First Home Buyer's consolidated their position as the most important group propping up Australian house prices. First home buyers increased their percentage of total owner-occupied mortgage demand from 28.6% in April to 29.5% in May. Nearly a third of all demand for new mortgages is coming from new buyers sucked in by the grant. Hmmn.

One final note. The average loan size for the first home buyer was $281,000. That was actually a $3,400 fall from the month before. But it's still $14,400 higher-or about 5%--than what the average loan size of all the other borrowers in May ($266,900). Max out your borrowing at the low point of the interest rate cycle. Hmmn.

Moody's economist Matt Robinson told a reporter that, "The policy stimulus from the Federal Government and the central bank has helped boost the housing market, offsetting the deterioration in the labour market conditions that would otherwise subdue the willingness of people to purchase houses...This is a 'prime example'' of monetary and fiscal policy working."

That statement seems like a 'prime example' of getting the analysis absolutely wrong. We'll explain why in a moment. But first, a word about abductions.

What the heck is going on in Shanghai? Chinese police have detained Rio Tinto iron ore executive Stern Hu on suspicion of "espionage and stealing state secrets," according to Bloomberg. Hu hasn't been charged with a crime yet. Three other Rio workers who are also Chinese nationals are being held.

Incidentally, the Age's Matthew Murphy is reporting that Chinese steelmakers have agreed to a 33% cut in iron ore fine prices and 44% for lumps. "The deal would break a tense nine months of negotiations between the Australians and the Chinese, which had allowed the June 30 deadline to pass while refusing to budge on their demand for a price cut of up to 45 per cent," Murphy says.

Let's recap. In late March, Treasurer Wayne Swan knocked back China Minmetals' bid for 100% of Oz Minerals based on the proximity of Oz's Prominent Hill gold and copper mine to the Woomera weapons testing range in South Australia. Then in early June, Rio Tinto abandoned its offer to sell an 18% equity stake to Chinalco and instead raised the money from shareholders and a joint venture with BHP Billiton. And finally, the Aussie ore producers refused to give Chinese steel makers a larger discount this year than customers in Korea and Japan got.

So perhaps there's some hardball going on now? There are more than just business interests at stake in the relationship between Australia and China. There is national interest too. Interesting times, eh?

Let's quickly get back to that nonsense from the Moody's economist about policy stimulus 'working' by supporting the housing market. It could be a simple case of diagnostic failure. He said the policies are, "offsetting the deterioration in the labour market conditions that would otherwise subdue the willingness of people to purchase houses." But is this true? And if so, is it something to celebrate?

First off, throwing money at people to buy a house when they are at risk of losing their job doesn't seem like a good policy at all. It seems reckless. It also seems like the height of stupidity. But the larger issue is whether you can correct a problem if you don't really understand its causes.

The correct answer would be, "no." The policy responses inspired by John Maynard Keynes call for the government to run a deficit and spend money that households and businesses will not. But this response assumes that aggregate demand (household and business spending) has fallen for no good reason at all and that all the government has to do is restore confidence (by stimulating the appearance of health) and everything will be fine.

Balderdash! The problem isn't that demand has fallen unreasonably. It's that credit rose too much. The economy needs to walk itself back to more production (creating value) and less credit-financed consumption. Recessions aren't caused by too little spending. They're caused by spending gone wrong in a credit boom (mis-allocated capital).

In his latest Gloom, Boom, and Doom Report Dr. Marc Faber says, "This is where I have the greatest problem with US economic policy makers [ed note. We'd add Australian policy makers to the mix]. I don't think they have ever recognised that the excessive, credit-driven expansion of the US economy was unsustainable in the long run and that, sooner or later, the current crisis was inevitable. But not only that!"

"Now that we all know that the monetary policies implemented after the Nasdaq bubble burst in 2000 led to the current crisis, US economic policy makers are attempting to restore economic growth through essentially the same policies; the difference, this time, being that gigantic fiscal deficits are also being created."

To be fair, not ALL Aussie policy makers are making the same mistakes. As we reported yesterday, Glenn Stevens seems to know that in a balance sheet recession, the way back to recovery is to patiently rebuild the balance sheet on a foundation of solid assets and reduced debt. That's the course he encouraged businesses to take.

It's Australia's government that has us worried, and it's both parties frankly. The worse the recession gets (it IS a recession and it will probably get worse, we reckon) the more tempted (and forced) the government of the day will be to borrow more and more and run the deficit higher and higher. This won't be good for confidence in Aussie assets.

Speaking of which, Faber also had something to say about the on-going feud between inflation and deflation. "Asset markets," he wrote "are buffeted by recurring waves of inflationary and deflationary expectations and I'm afraid we might now run again into a bout of deflationary fears. But unlike the deflationists, I don't expect new interest rate lows in this cycle."

"The interesting part about all this is how the various asset classes relate to each other. Equities and commodities seem to move up at the same time (driven by rising inflationary expectations and growth expectations), while bonds and the US dollar move down (the pattern since March 2009). But, when deflationary expectations increase, the US dollar and bonds strengthen while commodities and stocks decline (the patter of 2008)."

If Faber right and the deflationistas have the upper psychological hand, bond prices and the U.S. dollar go up and stocks and commodities will go down. For Australia, you'd probably see a weaker Aussie dollar versus the greenback and lower stock prices too. Meanwhile, the government will try to restore growth by running large fiscal deficits which may stabilise the economy a bit, but a lower level of output (as businesses stay on the sidelines with investment spending).

So how much lower could stocks go? Faber thinks it will be a few years before stocks make new lows (below the 2003 levels, we assume). He says stocks were oversold in March but overbought in June. Stocks are now priced for an economic recovery that looks increasingly illusory.

Two other things from the good Doctor. He expects to see rebounding corporate profits as businesses begin to reap the earnings benefits of cost-cutting and deleveraging. They will be coming off a low base anyway. So he may be right to consider the dismal upcoming profit season as a contrarian nadir.

The other interesting observation is that there is still a large cash position in the market. In fact, according to The Bank Credit Analyst, cash as a percentage of the Wilshire 5000 (the broadest index of U.S. stocks) is at its highest level ever. It's a veritable mountain of cash.

If we've done our maths correctly and the Wilshire has a total market capitalisation of nearly US$9 trillion, that means there's about $8 trillion in cash, money market funds, and savings waiting to hit the road. Where will it go?

It doesn't look like investors are buying the "green shoots" line being peddled by Ben Bernanke. That means the cash may not be going anywhere. Or-again using the Faber thesis-it could go into U.S. bonds. Faber also says that on a price-to-book basis emerging market stocks look a lot more attractive than U.S. stocks.

We reckon U.S. investors are still scorched from the last two years and would be reluctant to get back into the market with authority via emerging market stocks. That alone might make emerging market stocks good value for money. It doesn't really tell us where all the cash might go, though, does it? We can think of a few places and will have more to say about it tomorrow. Until then!

Dan Denning
for The Daily Reckoning Australia

• Wage Pressure in China to Drive Up Cost of Goods in Australia
• China Fueling Inflation in Australia & New Zealand
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• The Bubble Deniers Deny that Their Own Stimulus Caused it
• AUD Price of Gold a Measure of Gold’s Strength Against Other Currencies

This definitely sounds like a spurned lover. But what will the revenge be? Let's hope she doesn't have a knife. Or a blue water navy. Or an inter-continental ballistic missile.

Alas, for the new capitalists of the Chinese state this is a lesson that capitalism is not a romantic business. It makes for realistic bedfellows, not true love. Chinese deal makers may currently view the Australian resource sector has a harlot or a shameless "lady of the night" that has turned down a helpful offer the minute something more lucrative came around.

But that is assuming Chinalco's intentions with Rio were always honourable. And that is ignoring the fact that the "white knight" offer, made in Rio's hour of need, was also extremely favourable to Chinalco, given Rio's weakness at the time. But let's not take sides in this lover's quarrel, shall we?

And let's not lay blame, either, except, perhaps, with Tom Albanese, who deserves it. We suspect realism will prevail in the future relationship between China and Australia. A "let's-still-be-friends relationship makes sense for both parties, one of which has resources, the other of which needs them.

Time and necessity heal all wounds. But in the meantime, don't forget the flowers Mr. Rudd!

By the way, no one should assume that Australia will always have China to fall back on, whether it is for capital in a pinch, or long-term resource demand. China's apparent economic recovery is "mild" and "unstable" according to a study from The Development and Research Centre of the State Council in Beijing. "Although the economy has bottomed out, it was touching a flat bottom, instead of a V-shaped bottom," says the Centre's deputy director Zhang Wenkui.

With our unseemly interest in bond yields lately, we've completely neglected the idea that China may not inevitably rise to replace America as the world's dominant economic power or Empire. Its possible China itself could collapse. More on that subject tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Rumours Swirl Over Chinese Equity Stake in BHP Billiton
• Australia & China: Already Partners in the Commodity Boom
• BHP Billiton, Rio Tinto and the American Civil War
• Rio Scraps Deal to Sell to Aluminium Corporation of China
• RBA Leaves Rates Unchanged, Rio Wraps Up Negotiations

So what now? Well, the Chinalco bid came at the bottom of the market. Things are a bit better now. And shareholders seem eager to provide the needed capital rather than bringing on board a suitor whose intentions are at best, opaque.

It certainly takes Wayne Swan and the Foreign Investment Review Board off the hook. But the question of how Australia will manage future overtures from state-owned Chinese companies is still on the table, and will be for many years. China has capital and a large appetite for Aussie resources. That won't change any time soon.

But in the meantime, the market looks a little tired. The Dow managed to eke out a 77 point gain overnight. Aussie stocks, though, are in the red. The only real movers today are over in the commodity patch with oil and gold.

Dan Denning
for The Daily Reckoning Australia

• Wayne Swan Approves Chinalco Investment in Rio Tinto (ASX: RIO)
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike
• Were Chinalco’s Intentions With Rio Always Honourable?
• Australia’s Currency and its Economy Will Benefit from China’s Stimulus Package
• Australia & China: Already Partners in the Commodity Boom

It's not just that stocks are falling, although they did that yesterday in both Sydney and New York. It's that in the rush to the fill void of bankers who've currently gone on strike, more and more tax and pension money is being put at risk in markets. At this rate, if you're serious about your retirement plans, you'd better have a close look at what your government is doing to your money and your pension/retirement assets.

But let's go back to the beginning, with bankers going Galt. Going Galt, of course, refers to the strike of the wealth producers in Ayn Rand's book Atlas Shrugged. High taxation, wealth confiscation, and wealth redistribution drive a whole class of hero industrialists to take a runner on capitalism and retreat to a secret fictional valley in Colorado called Galt's Gulch, where they catch and grill trout and wait for the world to burn down.

The comparison breaks down now that we think about it. A small portion of today's bankers are not wealth producers. They are wealth stealers (or destroyers). But let's run with the idea that they are going on strike. What do we mean and what does the idea mean for Aussie mining companies?

By bankers going on strike, we mean that local Aussie banks are not doing much to help local Aussie miners raise money to stay in business. While the government has set up Rudd bank to fund "viable" commercial property developments (which indirectly supports bank loan portfolios), it apparently thinks the best thing to do for the miners is let them go broke (as they do at this stage of the resource cycle) or sell them to China. It is clearly of two minds on this last option (or of no mind at all, perhaps).

Why aren't the banks lending locally and what are they doing instead? Well, they're probably terrified that commodity prices won't recover any time soon, rendering the collateral posted by mining companies worth a lot less. Or, worried about future losses in commercial property, the banks are saving up for a rainy day.

In fact, one place they are saving is at the Reserve Bank of Australia. That's where banks can park money in RBA's exchange settlement accounts. Late last year, the banks were parking billions of dollars there overnight. For three days in October, the total figure crested over $10 billion and on December 19th, it spiked to over $16 billion. Using our crude Excel skills, we've built a chart of your showing the overnight balances in ESAs since the credit crisis broke in June of 2007, when two hedge funds owned by Bear Stearns went bust.

Source: Reserve Bank of Australia

The RBA pays an overnight interest rate on ESA balances that's 25 basis points below whatever the current cash rate is. It does this to encourage banks to lend money into the marketplace and not hoard it at the RBA. Or in the Bank's own words, "the rate on ES balances is set 25 basis points below the cash rate target to encourage ES account holders to lend surplus funds into the market rather than leave them with the RBA."

But here we are over eighteen months into the great global deleveraging and Aussie mining firms can't seem to borrow money from Aussie banks. "Mining companies will be forced to consolidate and seek further support from Chinese and other Asian state-owned interests as local and foreign banks baulk at committing to $36 billion in loans due from the sector in the next two years," report Jo Clarke and Katja Buhrer in today's Financial Review.

"The collapse in commodity prices has threatened the viability of new projects and slashed mining profits, pushing more producers down the path taken by Rio Tinto (ASX:RIO) and Fortescue Metals Group (ASX:FMG), which have sought large capital injections from Chinese state-owned enterprises." And Lachlan Edwards, head of corporate financing at Goldman Sachs, adds that, "The majority of mining companies in Australia are going to be dependent on fighting for limited bank availability,".

If you grant that a large portion of the debt that comes down is Rio Tinto's US$18.9 billion to pay for the Alcan acquisition, you still have a lot of company's left on the outside looking in. They really have only four options: tap private bond markets as BHP has in the last two weeks (although smaller firms won't be able to do this), rights issues to raise money from existing shareholders (hello Rio), asset sales, or...find a capital partner in China.

"But wait," says Australian Small Cap Investigator guru Kris Sayce. What about the $50 billion Future Fund? Does it have a role to play in capitalising Australia's credit-starved small cap miners?

"We're not sure what's going to happen to the Future Fund, but its chairman David Murray has put himself about recently." Kris writes in today's Money Morning (his daily e-letter on Aussie share markets) "We wonder if this is the first step in the transformation of the Future Fund."

"If you recall, the Fund was set up to cover the underfunded public defined benefit pension fund. The main sources of the funding were from government profits (i.e. It taxed more than it spent) and the transfer of the last batch of Telstra shares....So why the sudden increase in David Murray's profile? He's been pouring forth on the global economy, on the Australian banking system, and now according to The Age newspaper, credit ratings agencies."

"Our guess is that with billions of dollars under management, and the clamour for more stimulus packages, the temptation for the government to dip into the Future Fund and spend it 'in the national interest' will be too much to resist."

Hmm. Interesting. China Inc. has much deeper pockets than the Future Fund. But if Aussie banks and foreign banks won't extend new lines of credit to miners like OZ Minerals, maybe the Future Fund will. Stay tuned.

Also be warned. Investing the assets of public pensioners in the stock market doesn't always work out. Remember, the stock market is not a retirement machine. It involves risk. Just ask the Pension Benefit Guaranty Corporation (PBGC).

The PBGC is the agency set up by the U.S. government to cover the defined benefit pensions of employees of bankrupt companies. When companies aren't going bankrupt, it's not necessary for the PBGC to funded by Congress. The company can manage its own assets.

But lately, the PBGC has been pretty busy. And with Chairman Obama indicating that General Motors is headed for bankruptcy, the PBGC will have even more defined benefit pensions to pay out in the coming years. Too bad it dumped most of its assets into the stock market in the last few years.

The Boston Globe reports that, "Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks. Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds."

Be careful if you ever hear these words, "We're from the government. We're here to help you retire."

Run.

If the government can't manage pension funds, how do you think it's going to handle managing a company a complex, bankrupt industrial/financial enterprise GM? Granted, GM's deposed CEO Rick Wagoner is a model of incompetence. But is Barack Obama going to much better? Have you taken a look at HIS business plan for America? You know...the one that ends up with over $10 trillion in debt over the next ten years?

At first Obama's rhetoric was disarmingly pleasant and most vacuous. Change. Hope. A better tomorrow. Who is against those things? Who is for a worse tomorrow?

But behind the million dollar smile is a mind of malice toward free markets. WE are entering the age of command capitalism where the government becomes the lender (not real capital when you're borrowing Chinese money, but let's not quibble) and manager of last resort. The audacity of the command economy is that the folks in the White House can run GM better than the folks in Detroit. Truth be told, neither has been doing very well, which doesn't bode well for the country.

But if Australia is facing the consolidation of the mining sector as the number of cashed up capitalist and willing bankers dwindles, than Washington is witness to a consolidation of failed and failing institutions. Bear Stearns, GM, and who knows who is next are gradually swallowed up by the biggest and most wobbly institution of all, the Federal Government of the United States and its paper thin dollar.

Having said all that, the dollar rallied yesterday against foreign currencies and commodities. Oil was down. Gold was down. The greenback was up. How can that be?

We turn to the report we mentioned yesterday from the Economist (Manning the Barricades). The economist warns that repeated cycles of competitive currency devaluations could keep the U.S. dollar stronger for longer than most of us dollar bears expect.

"While devaluation does not rescue countries from weak global demand, it does provide help at the margin, as well as alleviating deflationary pressures. Consequently, under our main risk scenario, governments are happy to see their currencies devalue provided it does not have adverse consequences for solvency of borrowers."

"This results in repeated cycles of competitive devaluations. There are periodic calls for co-ordinated action to stabilise foreign-exchange markets, although agreements prove elusive. Under this scenario, the U.S. dollar proves stronger than U.S. policy makers would like, as investors continue to view the U.S. currency as a safe-haven of sorts."

There are lots of global players like the Chinese and Russians who clearly do not view the dollar as a safe haven at the moment. But at the moment, they don't have much to choose from. So perhaps the Economist is right. Competitive devaluations will continue, making the dollar a winner by default.

This means that the whole project of ruining the dollar is going to require even more effort by Obama and his sidekick Tim Geithner. And as Edward Chancellor points out in today's Financial Times, until bank lending rises to match the expansion in the global monetary base, inflation will not pass into the real economy.

"Monetarists concede," Chancellor writes, "that central banks are printing money in vast amounts to stimulate their economies. This will not lead to inflation, they say. The newly minted cash is not being lent out but stored in bank vaults.

"The 'money multiplier', to use the technical term, has collapsed. It is no secret why this is happening. Households and businesses are over-stretched and fearful about the future. As a result, they are borrowing less and saving more. As long as such fears persist, according to monetarist logic, the Federal Reserve can carry on printing money with impunity."

But there must be a penalty for such a rash expansion of paper money. The Economist explored that too in its dollar doomsday scenario. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Future Fund ‘Borrowing’ Program Amounts to Theft
• Your Average Australian Super Fund
• The Advice to Never Touch Your 401(k) is Not So Cut-and-Dried
• Should You Put Gold Into Your IRA?
• Superannuation Raiding Party Being Formed II