Your editor was semi-conscious over the Pacific ocean at the time, so he can't vouch for reports. But our 30 hour trip back from Baltimore, via Chicago, L.A., and Sydney gave us time to think. Are we just being a paranoid nutcase about the global economy? Or is the position - gradually reduce your exposure to stocks and increase your tangible asset holdings - pretty sensible in a world with soaring debt and ambitious socialists?

You'll find our answer in just a moment. In the markets, it's pretty sunny out. While most of Australia idled its way through Labour Day yesterday, the ASX/200 crested through 4,800. It was a six-week high for the index. And then the news got better.

Newswires report that Royal Dutch Shell and PetroChina have offered $3.31 billion in cash and stock for coal-seam-gas player Arrow Energy (ASX:AOE). There's some consolidation going on now in Queensland's unconventional gas sector. So what should you do?

Nothing. The time to do some speculating was in November and December of 2008. That's when our colleague Kris Sayce tipped two of the entrants in the CSG race in Queensland. As the projects were "de-risked" the share prices went up. We phoned up Kris down the hall this morning and it is long-since out of his LNG positions.

The point? You have to be a year or two ahead of these big ideas and risk looking like a fool to make the big money on them. There's probably plenty of safe money to be made still. And if you are not a speculator or you don't have money you can't afford to lose, you shouldn't be playing the small cap game at all.

But as we contended at a dinner in Baltimore last week, the best reason to be in equities at all right now is for the chance to make five or ten times your money. These are Taleb's positive Black Swans, the low-probability, high-magnitude events that are actually good for your portfolio. Your much better off owning a portfolio of disruptive technologies or prospective ore bodies leveraged to higher commodity prices than blue chip stocks. Why?

The share market as a method for long-term, safe wealth-generation is a dead letter. That is, it ain't gonna happen that way anymore. Stocks are up nearly 70% from their March 9 lows of last year. The reflation rally engineered by monetary and fiscal expansion in the last year has merely papered over some huge structural weaknesses in the global economy.

But more importantly, the share market is at risk now for a big fall as it was in the middle of 2007 when the Bear Stearns story broke. Since then the perimeter of global markets has gradually been overrun by the forces of wealth destruction. Investors retreat into a smaller and smaller circle of "healthy" institutions and currencies - which only heightens their risk to further asset write downs.

The basic problem is that the global illness of too much debt has been remedied by more debt, which is no remedy at all. France and Germany may bail out Greece. But who will bail out Europe? And who will bailout the United States when public debt could rise to be 716% of US GDP in the Congressional Budget Office's alternative scenario (see page 20 for the figures).

Of course if you really think stocks are cheap now, your best bet would to be buy them and hold them. It's worked before. But we wonder, given the demographic forces in the Western world, if there is simply going to be more sellers than buyers in the coming years as the boomers liquidate.

Granted, we're arguing for a change to the prevailing conventional wisdom of the last 30 years. But hasn't the last two years given you every indication that the world really is different now and that what worked for you before in investment markets may not work again?

Or if you prefer the argument in more concrete terms, have a look at what Karl Denninger has said about the systematic balance sheet fraud going on in the United States. Dennigner shows that the suspension of market-to-market rules for U.S. banks did not - surprise surprise - lead to any improvement in asset quality.

But it's only at liquidation when the banks are taking over by the FDIC that the banks admit they've been carrying loan portfolios at much higher valuations than market prices would suggest. They only realise their losses when they are technically insolvent on their fictitious asset values. You wonder how many U.S. (or Australian) banks are doing the same thing.

Denninger reckons, based on the write-downs in assets on the firms seized by the FDIC, that total unrealised losses on bank loans could be between $1.5 and $3 trillion. Imagine what that would do to credit markets. And if the Fed tried to paper it over, imagine what that would (will) do to the dollar. Now imagine having the chance to buy gold at $1,124 an ounce.

Of course the underlying assumption to the recovery narrative has been that the bank collateral would always recover in value once the real estate market recovered. And that would happen with the passage of time, low interest rates, and short memories.

But in America at least, it's nowhere close to happening. If anything, a second and destructive down leg is coming. This is why banks continue to hold large excess reserves at the Fed. They know they're going to need it.

The underlying belief to all of this is that the credit boom has already gone bust and assets won't fall any further. You see this fiction over and over in America with the ramshackle and largely failed attempts to modify mortgages with longer terms and lower interest rates. But the basic problem - the house just isn't worth that much - is ignored.

Here we are, then, a year into the rally. The great central bank counterfeiters of the world have pumped up prices - presumably so those in the know can sell at a smaller loss, or in the case of the investment banks, at a substantial profit. But the real economy remains massively burdened by debt. For the rest of this week, we'll look at why we think the end-game to all this will play out over months, and not years. And why it won't be deflationary. Until then...

Dan Denning
for The Daily Reckoning Australia

• A Sovereign Debt Crisis Bullish for U.S. Dollar and Bearish for Gold
• Corporate Debt is Just One Aspect of the National Debt Problem
• Debt Problem Has Not Gone Away
• It All Comes Down to Debt Again for NAB
• Australia Has Highest Household Debt to Disposable Income Ratio in World

As expected...the Bubble Era was followed by the Bust Era. We're in it now.

And as expected...the feds swung into action, busily making things worse. The last budget from the Obama Administration beats even our cynical expectations. We anticipated something stupid. But this is suicidal. Scandalous... More about that later...

And we expected that the crash on Wall Street would be followed by a bounce on Wall Street. We even guessed that it would recover about half of what had been lost - which it did. What surprises us is that it went on for so long. Even now, we're still not sure it is over.

Yesterday, the Dow went down 26 points - after a couple of days of 100+ gains. Gold fell $6, which wasn't bad considering how strong the dollar has been.

The dollar has gone up - but not exactly as expected. We thought it would go up as investors fled stocks and commodities. Instead, the dollar rose long before stocks and commodities began to fall.

Either the last phase of the bear market has begun. Or it won't be long before it does. Stocks can go any which way they want in the short run - depending on investors' delusions. But in the long run, reality catches up to them.

And the reality is: we're in a depression. Stocks gotta get with the program.

But since the depression is invisible to most economists, the burden of proof is clearly on us:

"Retail sales continue to soften," says one headline.

"Home ownership level falling to 67%," say another.

"Personal bankruptcies up 15% from January '09," adds a third.

Bear in mind that a year and a half has gone by since the slump began. If this were a normal recession, we'd be recovering by now.

Instead, another report tells us that the unemployment rate has topped 15% in 19 different states. Now, that's beginning to sound like a depression, isn't it?

Another report tells us that now half the states are insolvent. Why? Tax revenues have collapsed, while the politicians failed to cut spending.

The latest GDP growth report came in at a surprisingly high reading over 5%. But take out the restocking of inventories...and the federal stimulus...and you have a negative number. Which means, the stimulus isn't stimulating. It's displacing. The private economy is giving way to the government economy. This week, for example, the federal payroll hit a new record - 2.15 million.

What do all those people do? More on that some other time...

Which brings us back to the federal budget deficit. At 11% of GDP, it's matched only by the deficits of the war years - the War Between the States, WWI and WWII. Each time, lenders were willing to go along with such high deficits because the future of the country was at stake (or so they believed)...and because they were confident that the deficits would disappear after the killing stopped.

But this new deficit is a whole 'nuther animal. First, there is no real war going on. Second, there is no end to the deficits. The Obama administration itself candidly admits that the deficits stretch out as far as the eye can see.

Now, a question: since this is not like the deficits of the war years...why would lenders act as though they were? Why would they accept the same rates of return? The deficits are shocking enough in themselves. But while the quantity (in GDP terms) may be equivalent to those of the war years, the quality is totally different.

Which makes us think lenders are making a big mistake. They look at the deficits and say: 'we had deficits that big before...we survived.'

But these deficits are different. They are serious deficits without a serious war... They just get bigger and bigger. And they don't go away.

Investors are going to be sorry they bought US debt...

Here at The Daily Reckoning headquarters we're happy with a depression. It makes us feel at home. Baltimore has been depressed for the last 40 years. Ever since the riots of the '60s, the city's been going downhill. There are whole blocks that could be bulldozed to the ground...no one would object. No one would be displaced.

The city probably peaked out in the '20s. That was when the suburbs began draining off its best people. Then, WWII brought in different people - poor, uneducated, uncivilized hicks from the mountains and field hands from the South. They worked Baltimore's factories and destroyed its neighborhoods. Then, the best of them moved out too. Now, there's not much left.

Depression ain't so bad. You get used to it. You even get to like it. Restaurants empty. Parking lots deserted. Offices, movie theatres, houses - all abandoned. There's a sort of end-of-the-world, Zombieland quality to the city. Certain neighborhoods, we're convinced, are inhabited by zombies. During the daytime they are deserted. The Zombies must come out at night...who knows?

Is the US headed towards a 40-year downturn like Baltimore? Probably not. Baltimore's decline came about because its industries were no longer profitable...and its middle class moved out. America's middle class isn't going to leave. Who would take it?

On the other hand, her industries are clearly in trouble. When it comes to making things, other countries can make them better, faster and cheaper. The only exception we can think of is movies...and we're not sure about that.

In the Bubble Era, fantasists such as Tom Friedman imagined that the US had a lock on innovation and invention. Even that seems to be slipping away. What's the biggest new thing in transportation? The electric bicycle! No kidding. They are catching on in Asia and in Europe. Soon, you'll see them in America too. Well, that is if drivers don't run over too many bicyclists before learning how to share the roads with them.

Where were the electric bicycles developed? In China... Now, western firms are trying to copy the Chinese designs!

Bill Bonner
for The Daily Reckoning Australia

• Gold and Stocks Going in the Same Direction
• Where Do the Feds Get Any Money?
• How Does an Economy Expand When the Banks are Lending Less Money?
• Feds Say Don’t Worry About the Depression
• We Trust Gold Because We Don’t Trust Central Bankers

The damned bum takes a coffee break!

He spends all day, sitting on the sidewalk outside our office in one of the city's marginal neighborhoods. His back to the Communist Party headquarters building, he sits on a duffle bag. Red haired. Not bad looking. About 35, maybe 40, years old...he doesn't ask for alms. He doesn't do anything. He just sits there. Day after day.

But every day, at about 11:30, he comes into the café on the corner. That is also where your editor sometimes sits and thinks...and where, sometimes, he just sits. The bum orders a cup of coffee. So do we.

We almost forgot. Our beat is money. And we won't make any money hanging around the Café des Dames watching people come and go. So let's turn to the financial world...

Yesterday, the Dow was down 150 points the last time we checked it. And this morning, Asian stocks are falling again. China's stock market has fallen below its 200-day moving average - a bad sign.

Is this a little correction in the long upward climb of stock prices? Is it a pause in humanity's march to perfection? Or is it a resumption of the bear market that began 2 years ago?

The way we see it, things go up and down...round and round...back and forth. Human life may become more comfortable, with technical progress and innovation. But every life still ends in the same place it did a million years ago. Ashes to ashes...dust to dust...

And what about the life of a company? Or a stock? Or a bull market? You know the answer. They end up where they began, nowhere. Everything ends up in the same place...back where it started. The challenge, as near as we can tell, is to get there with grace and dignity.

Speaking of stocks, the Dow hit a low of 6,547 on March 9th of last year. Most observers believe that was THE low...the nadir of the bear market movement. We doubt it. Even at its low, investors were still fairly confident that stocks would perform well 'over the long run.' They saw the problem as a banking crisis...a liquidity crisis, not a fundamental failure of the economy.

And even at 6,547 the Dow had lost only about half of its value...leaving P/E ratios well above typical major bottoms. At major bottoms, you can buy almost any stock on the exchange for 5-8 times earnings. If you were buying the whole company, you'd get a yield on your investment of 15% to 20%. Nice deal.

But in March of last year, when the bear market found its first resistance, corporate earnings were falling too...leaving investors with P/E ratios closer to 20 than to 5.

The bounce lasted more than 9 months and recovered about half of what stocks had lost. If the bulls are right, stocks could correct here...and then go back to their bullish trend. If we're right, on the other hand, they will fall all the way back to their March 9 low...and keep going, until they finally arrive at their ultimate low. Then, you'll be able to buy major listed companies and get a decent return on your money - from the dividends.

If we're right, the economy is in a multi-year period of correction, de-leveraging and depression. The stock market has to notice, sooner or later. And it is bound to get a little gloomy when it realizes what is going on. That should take the Dow down to about 3,000-5,000 on the Dow index. It could be much lower...

The latest figures - keeping in mind that we don't believe any statistics unless we fiddled them ourselves - show new jobless claims down last week, but not as much as expected. Bloomberg quotes a 'senior economist' who tells us that the numbers are going in the right direction, but 'very slowly.' The four-week average number, meanwhile, is going in the wrong direction - it shows increased unemployment.

And what about the housing market?

It's hard to get a clear picture of what is going on. According to Case/Shiller prices are rising in many areas. But so are inventories. It now takes a record 13.9 months to sell a new house - up 50% from a year ago. This must discourage a lot of sellers. Those who can afford it may prefer to hold houses off the markets - waiting for a better season.

The housing market is probably like the stock market, in other words. Just a little slower. The first wave down was driven by defaults, foreclosures and marginal, desperate sellers. The next wave down will be driven by inventories...population trends...and the depression. Many owners still believe prices will come back, when the 'recovery' really gets underway. Most likely, they will be disappointed.

If there is any recovery at all...it will be weak, lame and tentative. People wanting to buy houses will look for bargains. Owners will take advantage of every positive move to release more inventory - depressing prices for many years ahead.

What would change things? Well, there is little hope that the crisis will go away. Mistakes gotta be corrected. Leverage gotta go. Depressions gotta do their stuff.

But the nature of the depression could shift suddenly - from deflation to hyperinflation. We don't expect it. But it could happen. And if it did happen, people might rush to get rid of paper dollars as fast as possible. You'd see a big boost in prices for just about everything - including stocks and real estate.

Even in this case, however, the increases may be less than the losses on the paper money itself. Very hard to predict. In hyperinflation all bets are off.

Do we expect hyperinflation in the US anytime soon? No. We expect years of Japan-like suffering. But we could be surprised...

Bill Bonner
for The Daily Reckoning Australia

• You Can Have a Deadly Depression and Dizzying Levels of Inflation Simultaneously
• Trends Make Investors Less Afraid of Risk
• We Trust Gold Because We Don’t Trust Central Bankers
• Investors Better Off Investing in Anything but Stocks
• The Dow Gives Up the Post-ZIRP (Zero interest rate policy) Gains

On Friday we argued there would be more. Q1 and Q2 earnings looked good in 2009 compared to the free-fall quarters of 2008. But that improvement has run out of stimulus and momentum. The U.S. labour market still stucks, to use a scientific term. And stocks are beginning to express their doubts.

It would be a natural time for stocks to object to their own valuations. U.S. investors were sitting on a 62% rally in stocks since the March lows of 2009. Hmm. That sounds vaguely like a 61% Fibonacci retracement. This leads us to the obvious question: is the March 2009 rally topped out?

Well you know what we think since we wrote it last week. More earnings results from IBM, Citigroup, Bank of America, Morgan Stanley, and Starbucks could confirm that reversal this week. Or not. We will just have to see.

Not that the power of U.S. earnings reports compels Australian stocks to follow the U.S. lead. It's a different market here, with different business conditions, and closer trading ties to China. But how will corporate earnings travel this year? It may not matter, honestly, given that P/E ratios are already so high.

On a totally different subject, the spot iron ore price is on the up and up. The spot price, according to Metals Bulletin, is around $135 a ton, which is a lot higher than the annual contract price of $61 per tonne. Some analysts are already calling for a 30-50% rise in the 2010 contract price.

If it happened, that would obviously be a big boost to earnings for the iron ore majors. But enough to justify current valuations? The more speculative play would be the juniors, although those too have already had a pretty good run since March.

Besides, Bloomberg reports that the Brazilian ore giant Vale is grabbing market share from Rio Tinto and BHP Billiton. Bloomberg says Chinese steel production is driving ore demand to a record 1 billion tonnes this year. Vale claims it can expand production faster than its Aussie rivals, and is set to grab 28% of the ore market.

Cheers to Saul Eslake for his civil and thoughtful reply to our criticism of his article on debt last week. A reader alerted us to his comment at the website. We'll have a closer look and a reply tomorrow.

Another reader writes in that it's nothing like 2007, as we suggested on Friday. The 2007 crash wasn't preceded by any signs or evidence of a correction. Today, on the other hand, we have two solid years of mediocrity from which share prices, or at least earnings, can possibly recover.

Possibly. But as we've been saying all along, in a credit depression, corporate cash flows will revert to historic means. There will be fewer profits in the economy as economic activity adjusts to lower levels of credit and loan growth.

That doesn't mean there aren't good businesses with growing profits to invest in. But you probably won't find them in the finance, technology, insurance, and media sectors like you could over the last twenty years. You'll have to do more research and take more risk. The good news is that this will cause more and more investors to give up on stocks as an asset class. When no one wants them, then you'll have a real buy signal.

Until then, we creep along in this petty pace from day to day. A great Money Migration is underway. And this could be the year it leads to a serious strain in the finances of the Western Welfare States. You'll want to own fewer stocks, more cash, and more gold in preparation.

An outlier? How about a Republican winning a Senate seat in Massachusetts? We have no recollection of the last time a Republican actually won a Senate seat in that state. There've been some close races in the past. But it looks like State Senator Scott Brown is giving Democratic attorney general Martha Coakely all she can handle and more.

CNBC ring-master Jim Cramer says a Brown win on Tuesday will trigger a huge rally. Cramer says investors will celebrate the "Pelosi Politburo Emasculation." He's referring to Nancy Pelosi, the female Speaker of the House of Representatives from the People's Republik of California. Cramer reckons a repudiation of Coakley is the high red-tide mark in America's "spread-the-wealth" Federal policy.

Dan Denning
for The Daily Reckoning Australia

• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• Should You Buy Stocks Now to Take Advantage of Bull Market?
• It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position
• We Expect No Recovery from the Economy
• The Interest Only Mortgage Option

We've come to Paris where the family is gathering for Christmas. It has been snowing off and on for the last four days. Yesterday, the snow turned to rain and melted on the ground. Still, the streets glisten, reflecting holiday lights and decorations. By 4 PM it is already getting dark and shoppers rush home with the treasures. By 6 PM the cafes are full of people enjoying drinks together...saying farewell to each other for the holidays...catching up...flirting...even discussing business deals.

We warn readers that we lost our reading glasses. Dear Readers will probably notice more errors than usual!

But reading glasses or no...the reckoning must go on.

Nothing much happened in the markets on Friday. So, we'll stop to think a bit about what has happened this year...and this decade.

You'll recall, of course, our Trade of the Decade - buy gold on dips...sell stocks on rallies. Well, we've been very happy with it. But the decade is coming to an end. It's time to thinking about the NEXT decade.

You'll also recall that as gold went up, we became more and more concerned.

When Lehman went down, it seemed obvious that the feds were going to do the wrong thing. We were right. They did. They put up trillions of dollars to 'rescue' the economy. Since we knew the 'rescue' wouldn't work, we guessed that they would continue pumping in money they didn't have in order to keep trying to do what couldn't be done. Under cover of an 'emergency' they were able to siphon off billions of dollars for their friends on Wall Street and for their pet boondoggles. And the voters couldn't complain...at least they were 'doing something' to fix the economy! This led to a very simple observation - eventually inflation (and gold) would go up even more. Because the quantity of money would increase faster than the goods and services that it could buy.

What bothered us here at The Daily Reckoning was that this analysis was too easy and too obvious. What's more, it was an analysis that was widely shared. We don't like it when our points of view become fashionable. And we don't like it when the "story" is too easy to tell and too easy to understand. When you have a storyline that everyone picks up, it almost always turns out to be wrong.

Then, the smart money began buying gold. John Paulsen made a fortune in the '07-'08 period by correctly understanding the bubble in the financial sector and betting against it. A few months ago, he announced his next big bet: gold. He explained that gold was a 'can't lose' investment. If the economy recovered, inflation would come back and push gold up. If the economy didn't recover, the feds would continue pushing money and credit into the system, making the eventual inflation worse than ever.

John Williams came to a similar conclusion. He noted that the recovery wasn't working...and that the feds had no choice but to continue piling up inflationary tinder. When the spark finally reaches it, he says, the result won't be inflation, but hyperinflation of the blazing sort.

We don't disagree. The logic seems right to us. That is what OUGHT to happen. But what bothers us is that Mr. Market is a contrary ol' coot. He always does what he ought to do. But he rarely does it when and how you expect.

What is he up to now? Darned if we know. The dollar is going up. Is it just a bounce? Or is it a trend?

What would be the most surprising and most mischievous thing Mr. Market could do? Make the dollar more expensive!

It would undermine hopes for an export-led recovery in the US (American made goods would be less competitive...)

It would whack the carry-trade speculators hard. They borrowed cheap dollars. Now they'll have to pay back expensive ones.

It would encourage people to save dollars rather than spend them - thus undermining a consumer-led recovery too.

It would also drop the price of gold - temporarily - shaking off the fair-weather gold buyers in advance of the next phase of the bull market.

So, ask yourself, dear reader... If you were as ornery as Mr. Market...what would you do?

Bill Bonner
for The Daily Reckoning Australia

• Dumb Money Eyes Stock Market While Smart Money Watches Economy
• Investors Better Off Investing in Anything but Stocks
• Where, Exactly, is this Economy Headed?
• Tell Us What Questions You Want Answered in the DR
• What’s Good for Goldman is Generally Bad for the Country

Here is a quick answer: no. We're still a long way from gold's ultimate destination. Our 'Trade of the Decade' was to buy gold on dips and sell stocks on rallies. The idea of that trade was that gold and stocks were going in opposite directions. Stocks were supposed to go down. Gold was supposed to go up. They would meet at some point, we imagined.

But lately they've been going in the same direction. Yesterday, for example, stocks rose with gold; the Dow added 126 points.

Which poses a bit of a dilemma. We think stocks are more likely to go down than up. Will gold go down too? Yes, probably.

Does that mean you shouldn't buy gold here? No, not necessarily. If you're trading, we'd suggest you wait. Gold is ready for a correction.

But it is usually a mistake to trade in an out during a major bull market. If the trade goes against you, you end up sitting by the sidelines as the market roars forward. You miss the best part.

Gold's best part is still ahead. And this is not just a bull market; this is a fortune maker. Gold still hasn't entered the bubble phase. It is just a very strong bull market. Eventually, it will soar...adding $100 in a single day. It will take our breath away. You want to be in it when that happens.

But is $1,200 the best price you can get to enter the gold market? Probably not. But it's not a bad price. You can wait for a better one; but don't wait too long.

John Hussman puts the odds of a major market crash sometime in the next 12 months at 80%. If stocks go, gold is likely to go down too. And it could stay down for a long time.

We keep our Crash Alert flag flying...and have a hunch the crash will come sooner rather than later. Day after day, the bubble gets bigger...and the pins get closer. Greece? Britain? The US?

Real estate? GDP? Bond sales? Christmas sales? So many pins...so little time.

One of the biggest pins is the record borrowing by governments. The longer it goes on...the bigger, sharper and closer the pin becomes.

Dubai was nothing...like getting stuck by a mosquito. It itches. It swells. But it does no lasting damage. It could be much worse. Now, the government of Dubai says that Dubai World is on its own. Good luck to the lenders.

Those Arabs are pretty smart. If the US feds had only done that with AIG, GM, Fannie Mae and other big debtors...the whole thing might have blown up and blown over ...and now we'd be picking up the pieces and getting back to work.

Instead, the pols and central bankers trod in where angels and sensible investors feared to go at all. Now, they're wondering how to tread out.

Germany announced that its deficit would not be as big as expected. Instead of 49 billion euros, it will be only 39 billion - below 3% of GDP this year. France says it's bringing its deficits down too - to less than 3% of GDP by 2013.

The US and the UK, on the other hand, are out of control - with deficits over 12% of GDP and no credible plans for substantial reductions. As we reported last week, these deficits are largely structural - that is, they are the product of many years of mismanagement, not just this year's crisis-respond claptrap. It's hard to bring them down because they include public health, unemployment, social security and defense measures that are very difficult to stop.

Yes, stocks will react, eventually. Gold will come down with them. Then, at some point in the future, gold and stocks will de-couple...and gold will head to the moon.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Dubai, Built on Debt and Sand
• Dubai, the Financial Center Built on Sand
• We are Confident the Bull Market in Gold is Not Over
• Arab Wealth Pours Back into Dubai
• Gold in the Next Stage of a Bull Market

But there are some strange and perplexing crumbs to collect from news reports this morning. Yesterday we learned that for the first time in 70 years, yields on 90-day U.S. government securities were briefly negative. Investors - if you can call them that - were happy to loan money to the U.S. government for 90 days - and lose money.

Normally, the only thing that could explain such an unusual preference for liquidity at the expense of return is abject terror of equities. But stocks have been moving on up nicely. The plunge in short-term yields can't be explained in terms of "risk aversion." So what's behind it?

It's a pretty interesting question if you simply phrase it: what kind of investor is happy to lose money over 90 days? Is the move to the short-end of the U.S. yield curve part of a broader shift out of longer-dated maturities (10 year notes and 30-year bonds).

Even the New York Times is starting to freak out about the amount of U.S. debt that must be rolled over in the next four years. The times article points out what we pointed out at the beginning of the month: U.S. debt is far more interest rate sensitive than ever before, which makes it potentially far more expensive to service if interest rates spike.

But that doesn't get us any closer to explaining the near-zero short-term yields. Granted, they were low to begin with. Maybe they are only unusual because they descended from such a low base to begin with. But is there another explanation that sheds light on what's going on in the markets?

One possibility, and we admit we are speculating here, is that banks are beefing up on liquid assets to bolster their capital positions. Whether this action corresponds with the end of the year or some other force, well, we have no idea. But without a corresponding fall in some other asset, the fall in short-term bond yields must represent a preference by institutions for T-bills and notes right now.

Our colleague Kris Sayce thinks institutions might be using T-Bills as collateral for other loans, pyramiding their way up to new balance sheet growth. It's possible. It's also possible that banks are buffering their capital positions in anticipation of...turbulence.

In today's Age, Eric Johnston begins his story with the headline, "Australian banks fail new capital test." Gee, that sounds familiar! "Ratings agency Standard & Poor's has warned that nearly all the world's big banks - including Australia's major lenders - have insufficient funds to cover their lending exposures and risk a ratings downgrade unless they move to bolster their balance sheets over the next 18 months.'

That might sound odd, considering that Aussie banks tapped equity markets for $20 billion in new equity last year. But did the new money actually bolster the balance sheet? Johnston reports that, "While Australian banks benefited from having a large exposure to low-risk residential mortgages, S&P said a narrow geographic and business base counted as a negative. It also noted that the capital raisings by the local banks had been used mainly to fund acquisitions or balance sheet growth."

More home lending baby!

It's probably a stretch - given we have no evidence whatsoever - to suggest that global banks (Australia's included) are bolstering capital by moving into short-term U.S. debt. It's also arguable that U.S. debt - even short-term near cash bills and notes - are a quality asset to be adding to your capital mix. But it's a lead and we're chasing it down.

Why does it matter? Well, the last time yields went negative like this was in 1938. That preceded a collapse in the stock market and the onset of the "Great" part of the U.S. Depression. Of course in 1938 the Fed began tightening up monetary policy again (prematurely, some argue). It won't do that today.

Meanwhile, some other troubling pieces of information from the bond market. Bloomberg reports that Telstra, "scrapped a domestic bond sale plan after it couldn't reach an agreement with investors on the terms of the securities. " Apparently bondholders "wanted the 10-year debt to include assurances compensating them if Telstra's credit rating gets downgraded."

Geez. Creditors are getting pretty choosy these days, aren't they?

There are other stories we'd like to have a closer look at today. For instance, a Brazilian steel-maker has plans to buy 16.5% of coal explorer Riversdale Mining for $190 million. This fits the pattern we described earlier this week of major international companies seeking to buy independent junior miners in order to guarantee resource supply. We'll have to ask Dr. Cowie what he thinks.

Time to board the plane now and cross the Tasman. We'll report tomorrow from the east coast of the North Island. Until then.

Dan Denning
for The Daily Reckoning Australia

• Surge in Chinese Bank Lending in 2009 Leads to Fall in Bank Capital
• U.S. Bonds Better than Greek or Other Sovereign Bonds
• If Unemployment Numbers Get Better So Will the Economy
• Fed Willing to Print Money to Buy More Bonds to Keep U.S. Interest Low
• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis

And counter to our prediction of an imminent, counter-trend U.S. dollar rally, the dollar is most definitely not surging. Take a look at the chart below. We've been writing about the decline of the dollar for nigh on ten years. So we looked at a ten year chart to tally up the damage. It is considerable.

Click to enlarge

What's at stake with the interpretation of this chart? If the dollar rallies on short covering from the dollar carry trade (a BIG if), then other "risk" assets like gold, stocks, and emerging markets would probably sell off. And yes Australian stocks, that includes you. As well as the Aussie dollar.

The chart shows that the index's 50-week moving average is set to cross below its 200-week moving average. That is mixed news. The first time it happened on this chart was back in early 2003. That was the early days of a long decline in the index. The second time, though the move failed to confirm the "flight to safety" rally of 2008 had staying power in 2009.

Once the fear that gripped markets in 2008 went away, the investment world sold the dollar and started borrowing en masse to buy other, higher-yielding currencies and assets (like the Aussie dollar and resource stocks). That's where we are now.

But based on the chart, is the next move down in the dollar index a new low, which the crossing of the long-term MA by the short-term MA would suggest? Or is it a false move? Will the dollar quickly and violently rally for some reason (geopolitical perhaps) that currently remains unknown to the human beings of this world?

"It's an interesting chart," said our technical analyst Murray Dawes. "But it is not useful for timing your moves out of or into trades related to the dollar's movement."

"So you're saying our chart doesn't have any useful information from a trader's perspective?"

"Not really."

Murray promised to show us HIS dollar index chart tomorrow. We'll bring it to you, live and in colour. But in the meantime, we think the one piece of important information communicated by our chart is that the dollar's trend is down. But there IS a catch.

The catch is that when this many people are this uniformly bearish, everyone is probably wrong. Consider this a warning then, that a dollar rally is just the sort of thing that will lead to a correction in the gold price and the stock market. We won't speculate on the sort of things that could lead to a dollar rally. But surely they're out there and sooner or later they'll come.

The other possibility is that the dollar is in its death throes and that this is the big one, in currency terms. That is such a momentous and disastrous event that people consider it both kooky and unlikely, not to mention undesirable to a predictable and comfortable world. But it IS possible.

And do you get the feeling that this kind of manic melt up rally is the sort of irrational frenzy that comes just before everything goes haywire? Haywire is not a precise financial term. So what do we mean?

We meant that the world enjoyed a 20-year economic relationship based on a fundamentally unbalanced global economy. Manufacturing capacity migrated to Asia where wages were lower. For awhile, this was mostly good news in Western countries. Goods got cheaper but jobs didn't vanish.

Now the situation is not so pleasant. The world is awash in manufacturing over-capacity, especially in China. Wage deflation (in the Western world) looks like a long-term trend, leading to a lower standard of living. This wage deflation is occurring at exactly the same time that Western governments are encountering demographic crises of ageing populations.

We all knew the ageing of the Boomers would put pressure on public finances right around now. But no one reckoned on a global financial crisis further saddling the public balance sheet with debt. And no one reckoned that Western wages and incomes would be falling at just the time people needed them most. And no one reckoned that savers would lose the most from low interest rates on fixed income - even though those low rates are keeping the American housing sector on life support.

It's a bit of global impasse. America's needed structural adjustment has come. Households and businesses are reducing debt, trying to live within their means. But the net adjustment to the American balance sheet is not happening because public sector debt is growing so fast.

Meanwhile, the other obvious adjustment is that the Chinese currency ought to be allowed to strengthen. For political and social reasons though, China will not allow this. It means China is actually adding to its industrial over capacity. It is conjuring up the world's largest ever bubble in fixed asset investment, including commercial real estate.

It is easy to see why China is reluctant to allow a stronger Yuan. Exports account for 39% of Chinese GDP. The Chinese economy, and probably the Communist Party itself, cannot survive on unleashed Chinese domestic demand. They need American markets. But American consumers - in addition to reducing debt - are now realising that the focus on finance over manufacturing from American policy makers has worked out for Washington and Wall Street, but not terribly well for the average American worker.

Where do we go from here? How about the blame game. U.S. Treasury Secretary Tim Geithner once blamed the Chinese for being currency manipulators. He back-tracked later. And yesterday, Liu Mingkang, the chairman of the China Banking Regulatory Commission, had a go at America.

"The continuous depreciation in the dollar, and the US government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation." He is blaming the U.S. for fuelling a destabilising global bubble.

Of course that bubble is felt most acutely because China pegs its currency to the dollar. China is right to blame the U.S. for manipulating its currency to try and improve its competitive position. And China is right to worry about the value of its dollar-denominated assets in a world of exploding U.S. debt supply.

But China has put itself in this position. And here we are at the end of 2009 with a world still fundamentally un-adjusted to a new, workable currency arrangement. The world remains burdened by trillions in assets purchased with debt. Those assets linger on bank balance sheets, on government life support but fundamentally lifeless at fictitious book value prices.

And meanwhile, the China-US currency arrangement has fuelled a global bubble. Australia is part of this bubble, too. The question is how it will end. In the U.S., the housing market looms as the Achilles heel of the economy. It could strike households, banks, and the government again in the next 12 months are more mortgages reset at higher rates (with lower home values).

If the event that pops this bubble comes from America, look for the supply of credit to the emerging world to dry up again. And though Australia is not a developing economy, we saw last time what happened when U.S. credit markets imploded. Australian banks had to get a government guarantee to borrow money in the wholesale market.

We'd suggest that lending for residential housing and commercial real estate would take a real dip in Australia on another U.S. housing crisis (even if Aussie banks aren't exposed to actual U.S. housing-backed RMBS and CDOs. You don't have to own toxic debt to be impacted by it.

If the bubble pricking comes from China, what then? Well, China does everything big. So a Chinese bust would be world-class. It's a subject that requires its own Daily Reckoning. More tomorrow.

Dan Denning
for The Daily Reckoning Australia

• CRB Index Correction Likely to Go Further
• U.S. Markets Could Rally on Oil Price Decline
• The Aussie Dollar as a Measure of Global Risk Appetite
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• Chinese Steel Price to Rise in Wake of Coal and Iron Price Hike

Then on Tuesday the market snapped up $25 billion in ten-year notes and yields fell. Sovereign debt? Big whoop! Whether it's the end of the year and investors feel safer in Treasuries, or some other reason, Tuesday's auction showed no signs of an impending "bond fire of the vanities." The bond bubble keeps getting bigger.

Today, though, the market gagged. In an effort to lock-in low rates for longer terms, the Treasury served up $16 billion in 30-year bonds. The market turned sour. Reuter's reports that demand for the 30-year was the weakest since May and that yields moved up as the weak auction triggered selling.

And then everyone seemed to lose their nerve. Stocks fell across the board. Gold set a new high at $1,123.40 in New York trading, before retreating. The weak 30-year auction has people thinking...what happens when Treasury supply overwhelms demand?

What will happen to bond prices then? To inflation? What should I do?

The rest of today's Daily Reckoning will be devoted to some constructive apocalysm. We may have left the impression yesterday that there was nothing but pain and heartache ahead for investors. But that doesn't have to be the case. But you have to start with the big picture. And that begins with the end of the bull market in bonds.

Check out the chart below from Ron Greiss at the www.thechartstore.com. Ron's chart shows long-term U.S. bond yields since 1941. Mostly this reflects the yield on 30-year bonds, although there were periods where 30-year issuance was discontinued. Either way, it shows a great cycle...which appears to be bottoming out.

What story does this chart tell? We reckon it shows you why the U.S. government (and so many banks and borrowers) are eager to sell as much debt now as possible. Rates are near historic lows. If and when they go up, it's going to make borrowing and servicing new debt even more expensive. Bond prices will fall and yields will rise again.

Now you could say that, according to the chart, there is room for another decade of low yields. The Fed, for example, could move to set rates further out on the yield-curve. It only sets rates right now for short-term debt. But the quantitative easing program has moved the Fed out to ten-year yields. It's done this to try and keep mortgage rates low, as mortgage-rates are keyed to U.S. ten-year yields.

But we reckon not even the Fed can keep yields low forever by supporting prices. It will have to wind down its programs eventually. For example, the U.S. government ran its largest October deficit ever last month, at $176 billion. Between demographics and existing debt, the Fed may not have the resources to support bond prices too.

Besides, you'd think markets would begin to tire of U.S. debt, given the lousy fiscal position of the American government. At least that's what we'd think. And if we were trading it, we'd look for put options on ETFs that track bond prices, or call options on ETFs that track bond yields. That would be the cheap trade.

The investment decision is to find assets that out run inflation as bond yields move up. Granted, this assumes there is going to be inflation, which is a whole other argument. But if you'll grant us the assumption, we'll continue with the strategy...of finding assets that beat inflation.

You don't have to look far. Gold...oil...iron ore...tangible assets are what you're after. Does this conflict a bit with our analysis yesterday that China's resource demand is more fragile than reported? Yes, it does. But it still pays to focus on those resources that will be in demand no matter how bad the global economy gets again. What do nation states really want to own? What can they not do without?

You know they can't do without oil. And you know more and more of them prefer to own at least some gold rather than rapidly devaluing foreign currencies. That leaves us where we began, buying oil and gold and selling U.S. sovereign debt. Production of the first two is hard to increase. Supply of the last one is growing.

"There is a strong case to be made that we are already at 'peak gold'," Barrick's Aaron Regent told London's The Daily Telegraph today. Regent was speaking at RBC's annual gold conference in London. "Production peaked around 2000 and it has been in decline ever since, and we forecast that decline to continue. It is increasingly difficult to find ore."

Gold exploration budgets are up. But with the exception of China, gold production from traditional stalwarts like South Africa and Australia has trended down. Alex Cowie at Diggers and Drillers recently wrote a report suggesting that the best Aussie gold stories are listed here in Australia but digging for gold in Africa, where they incur production costs in U.S. dollars and where there are more greenfield projects than recycled brownfield projects.

Frankly, we have no idea if gold production has peaked. Mine supply could grow this year for all we know. But finding and mining gold is not easy and it's not cheap. And even if the gold supply does grow, we'd take it to the bank that the global gold supply will not grow faster than global money supply.

And oil? Any scenario in which an economic collapse leads to falling GDP ought to mean lower demand for oil and lower oil prices. But the case for oil is not really about the demand side. You reckon that's bound to grow over time anyway, unless someone comes up with table top cold fusion. The real oil bull story is on the supply side.

Earlier this week the U.K.'s Guardian reported that, "The world is much closer to running out of oil than official estimates admit, according to a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying."

" 'The IEA in 2005 was predicting oil supplies could rise as high as 120m barrels a day by 2030 although it was forced to reduce this gradually to 116m and then 105m last year,' said the IEA source, who was unwilling to be identified for fear of reprisals inside the industry. 'The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this.'"

We remember writing about the IEA figure a few years ago. And we remember pointing out that producing 120 million barrels of oil per day would be a 44% increase on producing 83 million barrels per day. And you'd have to find that oil first. You'd have to explore, drill, and produce it. And you'd have to maintain existing production levels at the world's big elephant fields like Cantarell and Ghawar.

In point of fact, production at Cantarell has fallen by 25% since 2004. Energy expert Matthew Simmons says Mexico's days as an oil exporter will end in 18 to 36 months. This makes Mexico's government-which derives 40% of its revenues from oil sales-the most likely candidate for "next failed state."

By the way, if you think illegal immigration is problem in America now (and it is), imagine what would happen if the finances of the Mexican state imploded with a production catastrophe at Cantarell. The Obama administration would face another crisis, but this one right on its massive southern border.

Not everyone believes in Peak Oil. But it's not really a matter of faith. Either oil production is declining or it is not. It does not mean there isn't any oil left. In fact, technology has lengthened the life of productive fields. And technology has also made it possible to find and produce oil in increasingly hostile environments (deep water drilling, the Arctic, etc.)

Even rank and file petroleum geologists are mostly in agreement (and sometimes in disagreement with their corporate overlords) that Peak Oil is real and it's here now. But we make this point not to say that all is lost. It isn't. It's just the great changes in the world are afoot.

You have a secular bond bull that's long in the tooth. The post-war monetary system that supported the expansion of the fiscal welfare state through perpetual debt is failing. Energy, which has been getting cheaper and cheaper for years as we found more and more of it, may start becoming more expensive and harder to find.

That's going to make the world a slightly less friendly place. But for investors, there are heaps of opportunities. For example, right now Alex is looking at what the fallout from next month's Copenhagen summit is. It has opened the door to a great entry point for energy investments, but not necessarily oil. Fear not! Or fear a little. But prepare.

Dan Denning
for The Daily Reckoning Australia

• Attack of the Bond Yields
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• U.S. Bond Prices Rose and Yields Fell
• Higher Oil Prices, the New Normal
• Consumer Price Inflation has Spooked Investors Everywhere

"Why don't you move back into your own house," his father wanted to know.

"Dad, I've got a good tenant in there. Besides, it's not in very good shape. I'd rather sell it than invest more money in it. And there are so many places on the market, I can rent something better. Even after a big drop in prices it is still cheaper to rent than it is to buy something."

There are probably millions of homeowners who would like to sell - if they could. This hidden inventory of unsold houses will depress housing prices for a long time.

But there's a crisis coming in commercial real estate too.

"An extreme amount of commercial debt is to mature over the coming years," writes real estate investor George Karahalios in Marc Faber's Gloom, Doom and Boom Report. "And unlike the residential market, there is no safety net (Fannie Mae) for commercial loans. Instead investors must rely on financing through commercial banks, a few insurance companies, and other private lenders who now demand much higher interest rates and more equity for the risk associated with these investments. Thus, not even the Fed's printing presses can save commercial property prices, and I am expecting certain locations to crash, perhaps falling as much as 50-80% from the peak."

So you see, dear reader, there is bad news ahead - a lot of it. Stocks will go down. Gold will go down too - most likely - when people realize that the economy faces a long, deflationary depression...not a period of inflationary growth.

But while stocks are fair weather friends, gold sticks by you in foul weather too. Right now, gold is rising on good news. Eventually, it will soar when the news turns bad. (Though...not necessarily right away...)

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Inventory of Unsold Houses Will Probably Continue to Hold Prices Down
• The Housing Slump Has Fattened the Inventory of Unsold Homes
• REIT Investors Grown Complacent About Risks in Commercial Real Estate Market
• Trends Make Investors Less Afraid of Risk
• Commercial Real Estate May Be the Next to Fall