Let's start with the news in China. The central bank there cut one-year interest rates by over one percent to 5.58%. The rate cut is on top of the US$586 spending plan unveiled earlier in the month. Chinese factories, especially in Guangdong province, are being shuttered by owners in the face of much slower demand for consumer goods from America. Workers are idle, and not happy.

Now the problems get thorny for China's central planners. GDP is still forecast to grow at 5.5% in 2009. But remember China is in the midst of one of the great population migrations in human history. Millions of farmers have left the countryside for work in the cities. China's economy must crank out new jobs at the rate of 7% a year for those relocated people, or face the unpleasant side effects.

What are those side effects? Well, unemployment is the obvious one. But it's really the social instability generated from millions of unemployed with no viable economic options. No jobs in the city? Too bad. No jobs in the country? Too bad.

It makes you wonder whether the project of concentrating large populations in urban areas promotes instability, or whether it makes people easier to control. For the stability and legitimacy of national governments, it's an important question. Can they effectively govern AND deliver basic services to large cities?

On the one hand, getting food and water and energy to mega cities is a massive logistics challenge. Then there is the matter of policing those areas. Throw in some protests by the unemployed and you see how fragile urban economies/living spaces might actually be in the future, and how sensitive to numerous disruptions (violent and non-violent alike).

On the other hand, with big arterial roads that can be closed down and road blocks set up at key nodes in road networks, cities become more like vast outdoor prisons in times of crisis. Nobody gets in and nobody gets out without the proper papers.

Sadly, we believe events like those in Mumbai today accelerate us toward a global future where urban travel is permission-based, monitored by electronic surveillance (i.e. the GPS in your car also becomes a visa/passport which can be switched on and off by the authorities).

But that is all down the road. What's around the corner for China's economy and what does it mean for Australia? It means 2009 is shaping up to be a year in which governments pull out all the stops to keep the wheels of commerce greased and rolling.

"China's Chinalco hints at Rio Tinto buy," reports today's Australian. This comes after Rio's biggest fall on the Aussie share-market in 21 years. You'd think at these low prices Rio would be a screaming buy. But there's that little matter of debt.

No discussion of debt is complete without a check up on the United States of America, where consumer spending fell by 1% October, durable goods orders fell, and new home sales fell 5.3% for the month and 40% year-over-year, while prices are down 7% in the last twelve months.

That is the bad economic news. The stock market ignored all that and charged ahead. The S&P has had its biggest four-day run since 1933. It's now up 18% since November 20th. How about that for a bounceback?

The local market is weighed down by the worst-performing sector of 2008, basic materials. But that has not stopped it from opening up by almost three percent. Kevin Rudd's admission that a "temporary" fiscal deficit might be necessary could be contributing to the rally. Here's a hint though we doubt it will be temporary. And the conditions that have prompted it, though unique in their own way, have the same fundamental causes as previous crack up busts.

In fact, it's tempting to say that no one has ever seen a world crisis quite like this. Massive government bailouts...falling house prices...huge debt-to-GDP ratios...the inability of States to prevent terrorism within their own borders...an interconnected world-wide financial and economic crisis. Is it all new?

No. That part of it, the interconnected part, IS new. But the basic tension in today's world is not new. It's good old fashioned human nature and power politics. You could even say we are entering a new feudal period in world history. Whether it's a New Middle Ages or a New Dark Age is something time will have to sort out.

What's clear to us is that the politically powerful are using their influence to arrange government interference on their behalf. The financially weak are paying the price. Bankruptcies in the financial sector are prevented, partly so that rather than liquidating the mal-investment of the phony boom, debtors can be left on the hook and creditors (who get Federal money) will still receive interest payments from consumers.

Western capitalism, as Michael Hudson suggests, has been hijacked Wall Street-Washington oligarchs. Financial institutions are insulated from the free-market consequences of their credit orgy (failure and bankruptcy) by government bailouts. The Fed and the Treasury have stepped into keep Wall Street's asset values high, and transfer the liabilities to the public balance sheet, income-earning taxpayers will pay the bill for the next fifty years (if it's ever repaid at all).

Class-warfare...the 80-20 rule...human nature...it can go by many names. It's not new. And the world has always been interconnected. It's just today, the speed with which information is transmitted (and with which capital responds to the new information) is much greater than before.

It's a 24/7 great economic race to sort out the important stories from the noise, figure out what it means, and then, what to do (if anything). What it seems to be producing, however, is record confusion. For investors, that means a preference for cash and gold...while the smoke clears to see how the global financial landscape will really change.

Dan Denning
for The Daily Reckoning Australia

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