The Dow went up too - 203 points yesterday. It's over 10,000 again. Not very impressive for a bear market bounce. A 50% retracement would take the Dow to 10,300.

But you have to give the bounce credit. It's been going on since March. That is impressive.

And now everyone is bullish, except us. We'll see who's right... in the fullness of time...

Gold seems to be advancing towards a new milestone - $1,100. Makes us nervous. We always feel more comfortable out in the wide, open spaces...that is to say, in trades we have all to ourselves.

But gold is still a marginal holding by marginal investors - like us. Central banks - especially those in emerging countries - have very little gold. The man on the street doesn't know anything about gold. He wouldn't know a gold coin if it hit him on the head.

As gold becomes accepted as a true store of value, we can expect more and more people to want to own it.

Governments are running breathtaking deficits...and accumulating alarming debts. Japan has a national debt of nearly 200% of its GDP. Where did that debt come from? It came from 20 years of trying to buy its way out of a slump with borrowed money. Of course, it didn't work. But now, Britain and America are following the Japanese lead...and the Japanese are still at it! At the present rate, Japan's government debt will grow to 300% of GDP in 10 years. America's debt could grow to 100%...and then 200% of GDP...over the next decade (depending on whose projections you believe). And Britain, if we read the report in The Financial Times correctly, will have debt equal to 200% of GDP within 3 years.

Just what kind of crisis do these numbers portend? It's hard to say. Probably a combination of confidence, followed by debt default and inflation.

Would the US actually default? We agree with Paul Samuelson; the answer is 'maybe.' Samuelson, writing in The Washington Post:

"The idea that the government of a major advanced country would default on its debt - that is, tell lenders that it won't repay them all they're owed - was, until recently, a preposterous proposition. Argentina and Russia have stiffed their creditors, but surely the likes of the United States, Japan or Britain wouldn't. Well, it's still a very, very long shot, but it's no longer entirely unimaginable. Governments of rich countries are borrowing so much that it's conceivable that one day the twin assumptions underlying their burgeoning debt (that lenders will continue to lend and that governments will continue to pay) might collapse. What happens then?

"...People have predicted such a crisis for decades. It hasn't happened yet. The currency's decline has been orderly, because the dollar retains a bedrock confidence based on America's political stability, openness, wealth and low inflation. But something could shatter that confidence - tomorrow or 10 years from tomorrow.

"Despite huge deficits, interest rates on 10-year Treasury bonds have hovered around 3.5 percent. In time of financial crisis, investors have sought the apparent sanctuary of government bonds. But the correct conclusion to draw is not that major governments (such as Japan and the United States) can easily borrow as much as they want. It is that they can easily borrow as much as they want until confidence that they can do so evaporates - and we don't know when, how or whether that may happen."

Why wouldn't the US just "print its way out of debt?"

Because it's not that easy. In effect, the feds are trying to print their way out of debt now. They've added huge amounts to the monetary base. But that money is not getting into the real economy. Instead, it's going into vaults and speculations.

"Jittery Companies Stash Cash," says The Wall Street Journal.

And banks, too, borrow...but they don't lend. They can borrow at negligible rates of interest...and buy US Treasury bonds on a leveraged basis...producing a 20% yield. That means, the US dollar has replaced the yen as the go-to currency for speculators.

Net effect? Lots of cash in what appears to the Mother of all Carry Trades. The Financial Times:

"The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates - as low as negative 10 or 20 per cent annualized - as the fall in the US dollar leads to massive capital gains on short dollar positions."

But in the economy itself? As in Japan, very little economic progress comes from this kind of speculation.

Bankruptcies rose 7% last month. Unemployment gets worse.

The financial markets bubble up. The real economy shrivels up. And people with any sense are stocking up.

David Rosenberg, again, on gold:

We are still contemplating the massive gold purchase by the Reserve Bank of India - the largest in at least 30 years that took up half of what the IMF intends to sell. Look for China to come in next.

But here is the reality. All India did was bring gold to a 6% share of its total FX reserves from 4%. Fifteen years ago, that representation was closer to 20%. China has increased its gold holdings by 76% over the past six years but they are a mere 1.9% of the aggregate 2.2 trillion of reserves and Russia's gold holdings is just under 5%. This is not the 1990s when Bob Rubin was running a hard US dollar policy, US fiscal deficits were vanishing and gold production was on the rise. Today's world is exactly the opposite. Policymakers beginning in the 1990s wanted disinflation and got it. Now they want inflation - it will take years, maybe a decade, but it will come. For the near-term, we are still optimistic on Treasury securities but be forewarned that this view has an expiry date that is earlier than the peak we are likely to see in gold.

It is very clear that central banks are behaving in a way that would suggest that gold is now again being considered a currency within the global monetary system. As we said before, it is all about relative scarcity and a well-defined supply curve - fiat currency at this juncture does not share that quality. As a good friend reminded me yesterday, when the Fed was created nearly a century ago, it was acceptable to have at least 40% of the money supply backed by gold reserves. The US now has 8,133 tons of gold in reserve, which equates to $285 billion at this year's pricing.

Meanwhile, the Fed has spiked the punchbowl to such an extent that the monetary base now stands at $1.7 trillion. Do the math - under the old regime (which indeed hamstrung the Fed), the US alone would need to buy an incremental $400 billion of bullion or the equivalent of what would be nearly four times the typical level of annual demand. We could do the same calculation based on M2 but we don't want anyone falling off their chairs.

And finally today, we're still ruminating about what to tell you about our trip to the ranch. The funny thing was...it had little to do with cattle ranching...and a lot to do with the personalities that we brought with us. It's no easy job being a parent...especially when the kid is 38 years old...and not your kid.

More to come on that another time...

Bill Bonner
for The Daily Reckoning Australia

• Gold is Money
• An Irish Bond Bomb
• Denmark, Spain, the U.K. and Ireland Have Begun to Register Falling Housing Prices
• Where Do the Feds Get Any Money?
• Borrowing and Paying Back in a Foreign Currency

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

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

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

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

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

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

And what about gold?

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

So what?

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

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

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

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

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

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

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

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

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

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

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

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

Bill Bonner
for The Daily Reckoning Australia

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

Probably most incredible is that the dollar has NOT collapsed. It has lost ground, and was trading at $1.43 per euro on Friday, but no one laughs at you when go to exchange dollars...or offer to pay in dollars rather than the local currency.

For the last 10 years, the money supply in the United States has expanded at roughly twice the rate of GDP growth. And the Fed doubled its balance sheet in just the last 18 months. This last bit of information is stunning. It took the central bank nearly 100 years to build a balance sheet of $1 trillion. Then, under the leadership of Ben Bernanke, it added another $1 trillion in just a few months.

What does that mean, exactly? It means they bought a lot of debt from US agencies and the financial sector. It means also that they "monetized" this debt...transforming it into cash by paying for it with money especially created for that purpose. It also means that the whole financial sector has a bigger financial base against which to lend. The Fed lends against its balance sheet to member banks. These banks then lend to other banks who lend to business and consumers. So the amount of potential credit - as well as the amount of actual cash - has gone up.

There is an iron law in economics. Quality and quantity vary inversely...which is another way of saying that when you add more of something...each unit is worth less than the unit that preceded it (assuming everything else remained unchanged.) Certainly, this is true of money. The more money in a financial system, the less each unit of it is worth. Add enough new money - as Zimbabwe proved recently - and each unit becomes worthless.

But so far, the dollar has not collapsed. It has fallen, but gently...

Meanwhile, the inflation rate has NOT gone up. Instead, it's gone down. Go figure. You add that much monetary inflation and you'd expect to get a boost in the CPI. Nope. Not yet.

On the other hand, we're already a year-and-a-half into a major recession/depression. You'd think you'd get deflation. That hasn't happened either. Prices are down. But not as much as you'd expect, given the scale of the downturn.

Related to both the dollar and inflation is the bond market. Even more surprising is that the bond market has NOT fallen apart. Let's see, a huge input of monetary inflation; that ought to kill the bond market. Then too, the biggest sales of Treasury bonds in history - needed to cover a $1.7 trillion deficit this year. That ought to kill the bond market too. And on top of it all is a projection from the White House telling us that the feds will add $9 trillion to US debt over the next 10 years. And that assumes a full recovery in the economy! Now, that ought to kill the bond market for sure.

Not at all! Bond yields have risen...but the 10-year T-note still only gives you 3.4%.

Of course, you say, it's a depression. Bond yields always go down in a depression.

But if it's a depression, how come commodities are up? And stocks are up? Above all, how come Chinese stocks are up? Everybody knows China earns its money selling products to Americans and other non-Chinese. If the rest of the world is in a depression, who is China going to sell to? How come China isn't in a depression already? But there you are - there's another thing that hasn't happened. Chinese stocks haven't collapsed.

And getting back to commodities, they're all up. Commodity prices don't go up in a depression; everybody knows that. They go down. But commodities are NOT in a bear market. Go figure.

And, of course, there's gold. The metal gave up a dollar on Friday, but it's still just $4 short of the $1,000 mark...and just a shadow below its all-time high. Gold is a commodity...but it's also money in its purest, more reliable form. Commodities go down in a depression. Money goes up. But since gold is an alternative to paper money, it tends to go up only when paper money goes down. As explained above, the dollar has NOT collapsed. So why is gold going up? It should be going down, reflecting the effect of a recession...

There are two possible answers.

First, maybe the iron laws of economics have been repealed.

Or, second...maybe the iron laws just haven't caught up to the market - yet.

Unemployment is at 9.7%. It will probably rise above 10% this month. The economy is supposed to be recovering. Now, The New York Times is talking about a "jobless recovery."

You'll remember the phrase. It came out in 2003. Then, the economy was allegedly recovering from a micro-recession. Economists were surprised that there were so few new jobs created.

What was really happening was that there was no genuine recovery. Consumers just decided to go deeper and deeper into debt - egged on by the feds. A regional governor of the Fed actually urged consumers to "go out and buy an SUV." So Americans bought more products from the Chinese...on credit...and the Chinese enjoyed a boom.

And now the boom is over. Americans are paying down their debt. And unemployment is getting worse. This time the feds are pumping trillions into the system. This time, it's not the consumer who is willing to go further into debt; it's the government. And once again, few new jobs are being created.

Without jobs, the recovery is an impostor...a phony...a fraud. Without jobs, people have no extra spending power. So they can't buy - except by going deeper into debt. They were willing to go further into debt in '03-'07. But not this time. They've reached their limit on debt. Besides, with house prices falling, who would lend to them?

No new jobs = no new income. No new income = no new sales. No new sales = no new profits = no new jobs.

But what about the government? The feds are still willing to borrow. How come federal borrowing can't create a new boom - even if it is a phony one - like the one in 2003-2007?

Federal borrowing, spending, bailouts and monetary inflation are not helping the real economy. But they are making a lot of money available for speculation. That's why so many things are NOT happening. Investors are speculating on commodities, gold and Chinese stocks - for example. And US bonds.

But this is not a durable, reliable trend. And it's not laying the foundation for a genuine recovery. Borrowing by the feds is different from borrowing by individuals. Private households can go broke. But they can't take the dollar down with them. When the feds borrow, they pledge the full faith and credit of the United States - and its currency - as security. So, as they borrow more...the value of the US currency comes into doubt...then, into play...and then into jeopardy.

Investors eventually sell off dollars and US bonds...then, what should happen finally does.

Caution: what has to happen does eventually happen. But it doesn't have to happen when you think it should. The big surprise might be how long it takes before these things happen. If we were Mr. Market, for example, we probably would not take gold much higher - not just yet. We'd let deflation take gold down for a while - long enough to separate the speculators from their money. Then, we'd let investors get used to falling prices - before bringing inflation back.

Bill Bonner
for The Daily Reckoning Australia

• Where, Exactly, is this Economy Headed?
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Gold Doesn’t Always Need Inflation to Rise
• Fed Will “Monetize the Debt”
• We Expect No Recovery from the Economy

Stock action on Wall Street was mostly directionless. Stocks have opened lower here in Australia. But all the juicy action is in the bond market, where the Fed is getting its hands dirty again. You wouldn't think the Fed would have to come in and support bond prices with investors wringing their hands about global growth. But the numbers tell another story.

The Federal Reserve Bank of New York bought US$7 billion worth of Treasury bonds maturing between 2013 and 2016, according to Marketwatch.com. Remember, Fed announced last year it would buy up to $300 billion in Treasury bonds to keep interest rates down and borrowing costs low. But there's a slight problem.

According to Credit Suisse, the Fed would have to buy about $37 billion worth of Treasuries a month from now until September to reach its target. But in actual fact, the Fed's been averaging $59 billion in purchases per month since March. Hmm.

There are three points to come to mind here. First, the Fed is going to have trouble keeping long-term interest rates down through its repurchase program. Second, if talking up the bond-market and intervening doesn't work, it wouldn't surprise us to see the Fed talk down the stock market in order to drive investors back into Treasuries.

And the third point deserves its own paragraph. Debasement has consequences. It is perverse enough that the Fed must purchase U.S. government debt to keep rates down (and the bond market auctions chugging along). No one in the media calls this for what it is: market manipulation. But do you reckon there will come a day-perhaps this year-when a U.S. Treasury auction fails and the Fed is forced to buy up the whole lot with new money?

What do you think will happen to the U.S. dollar then? And here's a kicker...what happens when the U.S. Federal government begins throwing loan life-lines to debt-distressed states like California?

Dan Denning
for The Daily Reckoning Australia

• Federal Reserve to Buy $300 Billion In U.S. Treasury Bonds
• Fed Willing to Print Money to Buy More Bonds to Keep U.S. Interest Low
• China Reduces Holdings of Treasury Securities
• U.S. Treasury Auctioning Off $81 Billion in New Debt
• New Trend in the Market: Sell Bonds and Buy Commodities

Actually, we've seen so much already that it's hard to believe there's more coming. But there's sure to be more...and we have a feeling it will be worth the wait.

Yesterday, for example, GM filed for Chapter 11 bankruptcy protection. It couldn't pay its bills. GM was once the strongest corporation on the planet. But it has been around for nearly 100 years. Heck, everything wears out eventually...even a '55 Chevy.

"Obama Nationalizes GM," says a triumphant headline in France's La Tribune.

Triumphant?

Yes, according to the papers, Obama may have been handed the keys to GM...but the old jalopy is worn out. The French say the whole US economic model is ready for the junkyard. More on the French...and the French model, in our other article....

First, let's stick with the USA.

The Dow rose 221 points yesterday - to 8,821... Investors think the worst is over.

Everything is going up. Copper is up 65% so far this year. Oil is up 53%. Soybeans are up 22%. Stock markets are up about 30% worldwide. And gold is 12%. In this company gold is a laggard!

Copper has risen so much, say the papers, because China is buying all it can get. What it is doing with the stuff we don't know; maybe it is stocking up at what it believes are low prices.

Maybe it is hedging its bets. China has the biggest pile of Treasury bonds in the world - $768 billion of them. That's 768 billion reasons to worry. Because each T-bond is denominated in dollars...and while everything else is going up, dollars are going down. Yesterday, the dollar touched a new low against the euro for this year - at $1.42.

T-bonds are down too - minus 5% for the year. It would not be at all surprising for the Chinese to be stockpiling oil, gold, copper and all the other inflation hedges they can get. Their dollar-denominated bonds may go down...but their commodities and gold would go up. Overall, they'd come out even. You can also hedge your own nest egg with commodities.

Yet this week, Mr. Tim Geithner - the big banks' main man in Washington - is in China trying to reassure the Chinese that America takes its financial obligations seriously. That's something we never expected to see either. America may have the strongest economy on earth. But if the commies stop financing it, we're out of business.

So Geithner is in China, hat in hand, like a major debtor called into the bank president's office. Geithner, of course, has no choice. He has to go...and say what he has to say. He will use all the right words. He will show the appropriate seriousness...he will smile when it is called for...and put on a grave face when he needs to.

The trouble is, there's little he can do to help the Chinese. They want him to protect the dollar and the bond market. That's something he can't do.

"It will be helpful if Mr. Geithner can show us some arithmetic," said Yu Yongding, a former advisor to the Chinese central bank.

Yes, we'd like to see that arithmetic too. How do you add $1.75 trillion in deficits...pay for it with funny money from the Fed...and still come out even on the value of the dollar? There's no arithmetic we know of that works in the Chinese favor. Right now, the numbers...and the logic of the situation...are telling us that feds aim to create inflation. Instead of trying to keep prices under control...they're trying to get them to go up. That's yet another thing we didn't expect to see!

The US government is less concerned with protecting foreign lenders than it is with getting the US economy back to its old E-Z money ways. Cheap money is what people want. Cheap money is what the feds are trying to give them.

Today - will wonders never cease! - the US is pushing its phony money all over the world. The Chinese, meanwhile, are champions of financial integrity. Just wait until they give up on US bonds...then, we'll really see something we ain't seen yet!

Bill Bonner
for The Daily Reckoning Australia

• The Chinese and the Fed Both Buying U.S. Treasury Bonds
• American Family’s Share of Government Debt Now Over Half a Million Dollars
• Country Has Moved Towards More Government Intervention in Economy
• French Model of Economy Allows Meddling from the State
• China Has Stopped Stockpiling Metals

Wholesale I/S ratios tend to peak during recessions, with the bulk of the drawdown accomplished in the early recovery phase of the business cycle, when wholesale shipment growth revives. The inventory adjustment does not need to be complete to end a recession - the I/S ratio merely needs to peak, which appears under way.

Consumer credit growth remains moribund. Ratcheting up of minimum payments and interest rates is reducing the willingness and ability of households to substitute these sources of credit for housing-related credit. Bucking the trend is nonrevolving credit growth provided by saving institutions, although this has proven a very volatile source of funding for households. We do not see the private deleveraging theme ending anytime soon, as discussed in prior monthly letters. Policy to force banks to escalate lending in the face of the new frugality evident among U.S. consumers is likely to be thwarted, just as it was in the early 1930s. Weekly chain store sales have clawed their way back to flat and slightly positive territory over the past month. As with the wholesale results reported above, this is consistent with a less severe phase of the recession after the Q4 2008 freefall. Tax refunds, mortgage refinancing and price discounting may be helping those households still employed in stabilizing their spending before the fiscal package hits.

The past four weeks have shown some stabilization in initial unemployment claims, right around the same spikes of the 1982 recession. Initial claims tend to peak as a recession is closing out. While employment is generally a lagging indicator, initial unemployment claims have more of a coincident or slightly leading indicator tendency at cycle turning points. Since the maximum growth shock appears to be loaded into Q4 2008, it would make sense that the layoff response would peak one quarter later. A peak in the pace of layoffs is not to be confused with a peak in the unemployment rate, which we do not anticipate until Q2 2010 at the earliest. Still, if the high for the recession is developing in initial unemployment claims, and active fiscal stimulus is about to hit, this combination should help equity investors regain their nerve.

Refi applications continue to climb to their prior highs despite a slight rise in mortgage rates. While bank acceptance of mortgage refinancing applications remains restricted, this is an important channel for households to reduce their expenses and rebuild their savings. It also adds to fee income at banks. Purchase applications remain subdued, although they have picked up a bit in recent weeks.

The monthly U.S. trade deficit is shrinking at a dramatic pace as imports implode faster than exports. Falling oil prices are part of the import reduction, but with consumption cratering, imports are off nearly 30% versus a year ago. The turn in trade is clearly more than just price effects. In fact, U.S. export price deflation is running close to a 7% year-over-year pace as producers struggle with a collapse in global trade.

From a financial balance point of view, the more dramatic the turn in the U.S. trade balance, the easier it will be for the U.S. private sector to return to a net saving position. However, that poses serious challenges to production in the export-dependent economies abroad, and we continue to see harsh production cuts coming out of Asia. We would much rather see the U.S. trade balance turning with export growth remaining robust - instead, we have global trade collapsing because so many countries geared their growth strategies to an ever-indebted Western consumer. While many institutional equity investors have piled back into emerging equity markets over the past month because they are perceived to be the highest beta play, we remain concerned that excess capacity will prove to be a serious challenge for these nations as the globalized economy adjusts to a less-leveraged Western consumer.

All in all, the message continues to be one of a still sharp recession in the United States, with mounting evidence that the most violent portion of the downdraft is behind us. Evidence of a peak in I/S ratios, a peak in initial unemployment claims, improved refi activity and a dramatic reversal in the U.S. trade balance are all consistent with a recession that is still challenging, but not as overwhelming as the free-fall state that gripped the United States in Q4 2008. This is a better setup for the fiscal package to get some traction, although we continue to believe the earliest we might expect a positive U.S. real GDP result is in Q4 2009.

Technical measures of U.S. equity indexes continue to flag an extremely overbought condition. Given the run-up in the face of "less bad is good" news, we suspect equity investors have gotten ahead of themselves as they discard disaster scenarios. As mentioned last week, weak Q1 earnings results should be a catalyst for a pullback, although we are not convinced the prior lows will be violated, as too many institutional investors want to get onboard the rally train. We also are becoming increasingly concerned about the Fed's gambit with regard to Treasury yields. Once again, 10-year U.S. Treasuries approached 3% last week, which we would suggest is the informal yield ceiling the Fed is likely to impose.

The catch, as we see it, is as follows: If the Fed is forced to accelerate its Treasury purchases to keep yields from climbing above 3%, bond investors will tend to view the subsequent expansion of the Fed's balance sheet as "monetizing" the fiscal deficit. Foreign investors are likely to be especially wary of this, and the weakness in the currencies of nations with central banks pursuing quantitative easing has been conspicuous in the past few weeks.

In addition, to the extent the Fed is suppressing interest rates, and that successfully pushes investors into riskier asset classes like equities in order to earn adequate returns, Treasury bonds become a less attractive investment. Either way, the success of the Fed in these operations strikes us as making it harder for the Treasury to sell new bond issuance to private investors. The Fed could be unwittingly setting itself up to become the largest buyer of Treasuries, which we believe would aggravate the monetizing fears mentioned above. The movement in platinum, palladium and copper of late suggests monetization fears are present even in the face of outright deflation appearing in a number of final product price measures in many countries.

Best regards,

Rob Parenteau
for The Daily Reckoning Australia

• Housing and Unemployment Are Weaknesses in the U.S. Economy
• More Money in Cash Right Now Than Equity in U.S. Companies
• Difference Between the Dollar and the Yen
• Government Stimulus Programs Make Life Harder For Banks
• Level 3 Assets Growing in All Five U.S. Investment Banks

The Bernanke Fed announced a "stunning" plan to save the world from depression on Wednesday.

The numbers were hard to follow, but they were big:

$300 billion, was the number Bloomberg reported

$1 trillion, said the New York Times.

$1.2 trillion, countered the Washington Post.

It turned out that all these numbers were correct. The Fed was going to buy $300 billion of U.S. Treasury bonds...and more of other securities - notably bonds from Fannie and Freddie.

"Quantitative easing," the papers called it.

"What's that?" investors wanted to know.

So, it took them a while to put two and two together. But when they'd done the math they began to see what we've been warning about.

"This is a very powerful and aggressive move," said the chief economist at Bank of New York Mellon Corp., speaking with Bloomberg Television. "One of the reasons I've been arguing we won't have a depression is we've got a Fed chairman who understands the problem and is going to come with the right diagnosis and the right medicine."

Bloomberg continues: "With the purchases of Treasuries and housing debt, Bernanke is effectively using the Fed's powers to print money and aim it where he and other officials believe it will have the greatest impact in lowering borrowing costs."

What do we know? Maybe Ben Bernanke will be able to do what no central banker has ever done before: put in just the right amount of inflation...not too much, not too little. In the past, they tended to overdo it. There are not many examples. France, England and America in the 18th century. Practically no examples we know of in the 19th century (they'd learned their lesson!). And in the 20th century - only marginal countries...or countries with nothing left to lose...engaged in 'quantitative easing.' Germany did it in the 1920s, because her war reparations burden was greater than she could sustain. Argentina did it in the 1980s, because it owed too much money to too many foreigners. And Zimbabwe did it in 2003-2009, for reasons of its own.

There are not many examples because the consequences of over-doing it are so horrible, central bankers have generally not done it at all. Quantitative easing was always a possibility...but it was always a last resort...like blowing up the powder and spiking the guns; it was something you did when you knew you'd lost the battle already.

But here is the world's biggest economy and its oldest (arguably) and most successful government...doing something that used to be done only by desperadoes...

What does it mean? Where does it lead?

We don't know. But we don't think we want to go there.

Investors didn't seem to want to go there either. They sold off stocks and bought gold.

Gold shot up on Wednesday, after the Fed announcement. Then, it just kept going...adding another $70 yesterday. We wondered why the price hadn't already hit $1,000. It looks like it soon will...this morning it is back over $960 an ounce.

Meanwhile, oil rose above $50, the dollar took a big drop and the Dow finished down 85 points. The greenback slipped to $1.36 per euro.

As to the stock market, whether this is a pause in the rally...or a reversal, caused by the Fed announcement...we don't know. Our guess is that it's just a pause. The rebound is still unfinished business. Besides, investors aren't running scared like they were a few weeks ago. Sentiment seems more relaxed. "We'll muddle through this somehow," investors tell themselves.

And the news appears more positive...at least, if you stand on your head and look up it.

Jobless benefits, for example. They're getting paid out to a record number of recipients. But not as many as economists had expected.

The leading indicators are down 0.4% in February - but not as much as expected.

And consumers are spending less money - but not as much less as expected.

And, of course, there's the money flowing from Washington. The auto suppliers just got $5 billion. Obama's budget will probably reach $2 trillion in deficit this year. And this extra $1.2 trillion from the Fed is not exactly small change. And that's in addition to the $11.7 trillion the feds have already ponied up in their fight against a free market. Investors are going to look at this flood of cash from the Fed and figure that it has to go somewhere. Some of it is bound to go into the stock market.

Now, we turn to our friends in Baltimore to see what the have in store for us...

"The larger [monetary] story," opines Rob Parenteau, lending a The 5 Min. Forecast a hand today, "can be found in the deleveraging effort of households, which accelerated in the fourth quarter of 2008.

"We have never seen such a sustained buildup of credit flows to the U.S. household sector like the one that began in the late '90s. Nor has the U.S. economy experienced such a reversal of household credit flows since the Great Depression.

"Policymakers, investors and entrepreneurs need to grasp this essential piece of the puzzle:

"There are good reasons why the household sector is are paying down debt in an environment of declining asset prices and personal income. Falling asset prices reduce wealth faster than households can pay down debt.

"We believe this has a number of very important implications, not the least of which is for the restructuring of global growth away from a growing dependence on consumer debt binges in Anglo-American developed nations. Not to mention the policy objective of renewing lending to the private sector... it's misguided."

And yet, it's the very core of the justification for the TARP bailout and the broader Congressional stimulus plan. Rob unpacks this phenomenon in the latest issue of the Richebächer Letter entitled "Deleveraging Demystified".

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

And back to Bill with more thoughts...

"Fed's decision to put more money into the financial system reflects its worry that the U.S. economy is plagued by excess capacity," says the Wall Street Journal.

As we keep saying, the economically correct thing to do would be to let the excess capacity sort itself out. People lose their jobs - and get new ones. Factories close down...and open up again, producing something else. Companies go broke...and new companies spring up to take their places. That's what needs to happen. Then, after this restructuring, the economy can begin rebuilding on a more solid foundation.

But the Fed doesn't listen to us. Ben Bernanke is determined to stop a Japan-style depression from happening in the United States - at all costs. And the only way he can possibly stop it - by his logic - is by increasing demand. Putting more money into circulation gives people more money to spend. It also raises prices - giving them a reason to spend it now.

"Will it work?" was the question put to our little band of analysts this morning.

"It depends on what you mean by 'work'," was the answer.

Bernanke has set the blaze...broken the glass...and pulled the alarm. Now, the sirens whine and the crowds form. He has no choice but to follow through. What that means is that he must continue fanning the flames...inflating the money supply (monetizing the debt)... until consumer prices rise (reflecting an increase in demand).

We don't know how long that will take. But in that sense...it will work...sooner or later. Prices will rise...people will spend.

But what else? Do prices suddenly go wild? Or, do they gently rise...giving the feds time to get out the fire extinguishers before the whole economy burns down?

We don't know. But here is a guess: between the time the flames shoot up out of the roof...and the time the feds have the conflagration under control...you'll see gold over $2,000 an ounce.

*** Poor Tim. The U.S. Treasury Secretary is "out of the loop," says one source. He's "on thin ice," says a member of Congress.

He appeared on TV and said he couldn't stop the AIG bonuses. Then, the next day, his boss goes on the air: "Yes we can!" says he.

"US moves to take back bonuses," says today's Wall Street Journal headline.

Geithner has only been on the job a couple of months. And he's had to deal with bailouts, meltdowns, regulatory restructuring. It's a "crushing workload," says the New York Times.

But it's the bonus sideshow that gets people's attention. And poor Tim is on the wrong side of the story.

Bill Bonner
for The Daily Reckoning Australia

• Feds’ Plan is to Reflate the Economy
• Geitner Plan Falls Short
• Gold Calls Bernanke’s Bluff
• Daily Reckoning Plan to Save the World
• Obama Admits: America is Out of Money

There is nothing we can do to prevent Big Pond from blocking the DR from your inbox. Because the DR now goes out to around 50,000 Australians every day, someone at Big Pond (or some program) has concluded we must be a spammer, so e-mails from our server are either marked as spam or blocked. It is, as Vicomte Valmont says in Dangerous Liaisons, "Beyond my control."

Our suggestion is that you harass Big Pond. We had the same problem with Optus a while back. Once we get the name and phone number of someone at Big Pond you can call, we'll pass it on. Meanwhile, in the words of Frederick Douglass, "Agitate!" Or, if you work at Big Pond and have a suggestion on how the Daily Reckoning can clear its good name and begin broadcasting to the public again, drop us a line at dr@dailyreckoning.com.au

Now to the markets and the Australian government's growing concern about the commercial property sector. The issue gained added urgency yesterday when Westfield Group said it would take a $3 billion write down and cut its dividend for 2009. It blamed U.S. property markets.

Access Economics economist Ian Harper told the Australian that the hip bone is connected to the leg bone. "If there is a major collapse in asset prices in the commercial property market, that could feed through into domestic housing," he said. "Given the exposure of the domestic banks to housing...that is what we're trying to avoid at all costs."

He was referring to the plan announced over the weekend whereby the Australian government , in partnership with the Big Four banks, establish a slush fund to help commercial property owners roll over debt they cannot finance in the international capital markets. If they can't do that, they'd be forced to sell assets to raise capital and equity levels. And when you sell assets in a distressed fashion, it tends to further accelerate the decline in asset prices.

Big subject. Very complicated. More on it below. In the meantime, let's just remind question the basic assumption that the temporary provision of liquidity for borrowers addresses the larger issue of inflated asset values. It doesn't. That means everyone here-from the government to the rate cutting RBA to the Banks-is trying to sustain the unsustainable (and they're using your money to do it.)

Before we get to the collapse of complex asset values, more about gold and the dollar and the forecast for commodity stocks. Yesterday we mentioned that the expiration of the Central Bang Gold Agreement in late September this year may usher in a new phase for gold's role as a reserve asset. Banks will start hoarding it rather than selling it.But what's this? Yesterday's Guardian reports that numbskull politicians in Germany want to sell the country's gold in order to finance the stimulus package. This is a bit like junkie's who sell their body for drug money. The addiction leads to debasement, while the high is fleeting. Coming down is even worse.

The Guardian reports that, "German Finance Minister Peer Steinbrueck warned on Wednesday against the central bank selling gold reserves, after a senior conservative said the Bundesbank could do so to help finance government stimulus measures." See. The finance ministers understand the inherent value of gold as a reserve asset. Not only does Germany own 11% of the world's gold reserves, but also, 64% of its monetary reserves are in gold, according the World Gold Council.

Why would the otherwise prudent Germans trade real gold for paper money? Well maybe they won't, which is what we suggested earlier this week. "I don't believe there is any chance of this being realised over the next year," Eugen Weinberg told the Guardian.

Weinberg is a commodities analyst with Commerzbank. He added that, "Although the Bundesbank has a quota (for sales) under the Central Bank Gold Agreement, I don't think any of it will be realised. Every time the gold price is rising, and every time the gold price is at some important level...(there is talk of this)...But I don't think there is any chance of it happening. It is not in the interests of the central banks at the moment to sell this ultimate safe haven."

Only a blockheaded bureaucrat with no understanding of monetary history would sell a nation's gold at a moment like this. It's a bad trade. But since when are politicians good traders?

If you're looking for a good trade right now, by the way, Jeff Clark says you should sell the U.S. Dollar and look for a corresponding rise in commodity prices. In a note Jeff sent out to clients in the U.S. yesterday, he showed a chart like the one below.

The dollar index measures the U.S. dollar against a basket of other currencies. You can see that it rallied during the same period that investors flew into U.S. Treasury bonds and notes. It's nice to invest alongside the Fed, isn't it? But the very same week that the Bernie Madoff Ponzi scheme hit the papers, the greenback began to buckle, and whispers of a trillion dollar stimulus in Washington and Fed buying of Treasury bonds undermined the rally.

The trading action since then, Jeff suggests, is a deceased feline rebound. A dead cat bounce. This particular deceased feline may have run out of upward momentum. Yesterday's close on the dollar index leaves it hovering just above its 50-day moving average. Look out below!

If the U.S. dollar gives ground, it may not be against the Australian dollar. But it could give ground against oversold commodities. The question is whether or not this will mean a rally in Australian commodity stocks?

You know our position based on the last two weeks. It will be hard for most sectors of the resource market to rally on stronger earnings this year for the simple fact that earnings aren't going to improve a lot (energy, ag, and precious metals excepted). What's more, you have the IMF reporting today that world trade collapsed by an annualised pace of 45% in the last three months!

Double Daloob! A 45% contraction in trade? Is that already factored into resource prices? Or does it suggest, as we believe, that there won't be any recovery in industrial production this year, and thus no relief for industrial commodities and base metals (despite their oversold status?)

About the only good thing you could say is that the last few days indicate the amount of selling seems to have diminished in the resource sector. Leveraged funds and institutional players seem to finally have cashed out. That leaves room for a rebound, by virtue of their being so few sellers in the market.

But even if that's correct, it only argues for a short-term rebound in most resource shares. This is not the Obama rally. But it is the rally you should sell into to liquidate base metals and bulk commodity positions, if our take on the situation is correct.

Now, back to commercial property and the "Bad Bank" idea in the States. A warning first, though. We're thinking of moving this type of discussion to a weekly newsletter format, where we'd have time to edit it. It would be shorter, and perhaps not try your patience so much as we work through our thoughts here in raw format. Stay tuned.

In the meantime, consider the thought that Australia and America are headed down the same road to failure in their attempt to support asset prices, whether it be through a special fund for commercial property or a "Bad Bank" to buy toxic assets, as is currently being discussed in Washington.

Make no mistake, the idea of creating a new fund to finance commercial property is a mini-version of the "Bad Bank" idea in the States. You might say, charitably, that the Australian fund is designed to prevent the assets from going bad in the first place, whereas in the States they are ALREADY bad. In fact, that's just what Wayne Swan is claiming.

"What Mr. Turnbull and Ms. Bishop don't seem to understand," Swan said in response to opposition criticism, "is that a collapse in commercial property prices would not only seriously impact on confidence, activity and jobs in the sector, but also risk undermining the stability of our financial system." But why is that true? Why is a commercial property collapse such a trigger event?

Mr. Harper of Access economics said that the connection between residential property prices and commercial prices is "too close for comfort." He's partly referring to the fact that Australian banks own a lot of both. Falling asset values set in motion a now familiar and unpleasant cycle: deteriorating capital adequacy, the need to sell assets to raise cash, and the knock-on effect of forced asset sales leading to lower asset values. You can add to that rising unemployment as the business sector deleverages its balance sheet and both sells assets and cut costs (the biggest of which is labour.)But now we really come to the question that is probably keeping so many people up so late at night. Is there anything anyone can do to keep asset values where they are? There is $52 trillion in credit that went into driving those assets up. Take that credit away, and the value goes down. Incremental efforts to prop asset valued up simply won't work.

There are two conceits or mistakes that lead policy makers to believe that they can prop up asset values. The first is that the lack of a price for distressed assets is what's leading to the collapsing market value, not some fundamental trouble with the asset itself. This position-forcefully advocated by FDIC President Sheila Bair-is that assets values will "normalise" once the government helps establish a market and a "rational price."

In an interview with the Wall Street Journal, Bair put it this way, "The idea here is that the aggregator bank [a bank set up to buy toxic assets] would buy the assets at fair value. Some are concerned that you'd have to mark the assets down to purchase them, but I think it could help provide some rational pricing, actually, for the market in some of these assets because we don't have really any rational pricing right now for some of these asset categories."

That's not exactly true. How can the "fair value" price be rational while the market price is not? The assets aren't trading because traders either don't know what they're worth or, alternatively, don't think they are worth anywhere close to what the banks call "fair value." Using government funds to establish the price is a loser of an idea for a simple reason: the government is not using its own money. It is not behaving rationally, out of self-interest, at all.

Other market participants (banks, hedge funds, private equity) ARE using their own (or shareholder money). So why on earth would those potential buyers concur with Bair-who's spending tax payer money-that the price she's willing pay for these assets is what they're really worth? She's got nothing to lose! It's not her money! And therefore, it cannot possibly be a "rational price."

Prices for financial assets ceased to be rational about the time Alan Greenspan ceased to have integrity as a central banker. But let's give the man his due. He knew exactly what we were all getting ourselves into. In December of 1996 the then-Fed Chairman famously said:

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

Here is an answer to Greenspan's question: we know that asset values are due for an irrational escalation when the return on capital exceeds the cost of capital. And boy was that ever true over the last ten years!

The absurdly cheap cost of capital established by Greenspan and his central banking peers through interest rates-the cost of capital also being the price of money-did exactly what Mr. Magoo said it might: it grossly inflated asset values for ten years. As Dr. Kurt Richebacher so often explained in his letters, the only way to keep asset values high once the credit got into them (stocks and property) was ever larger amounts of credit creation.

But there is not a lot of credit being created now is there my Precious? No. There isn't my love.

Perish the thought that cheap credit was responsible for the appreciation in asset prices. If that were true, it would mean we face much steeper falls in asset prices as the credit depression lengthens. It also means that if risk premia for stocks and bonds are to return to higher levels, then the cost of capital HAS to go up. After all, if money is cheap and easy to borrow, you wouldn't expect to get much reward for taking borrowed money and buying common stocks. Yet that's exactly what happened!

All of that is now unwinding. And there like a Paper Wall standing in front of the asset deflation and credit deflation are an army of paper mongers trying to print their way out of it. But further injections of taxpayer money, or even worse, public borrowing to subsidise commercial property values (or toxic bank assets) is worse than throwing good money after bad. It is the willing destruction of future capital and savings via borrowing and deficit spending. There is nothing "fair" about it. It's unfair, unjust, and immoral.

The challenge for Bair and Obama is to get the market to want to pay something closer to fair value for the bad debt than the current market value. In other words, you have to turn the market for bad debt back into a marketplace where price tells you something about the value of the asset. If a reflexive fair-value bid from the Feds won't do it, you need to rethink the plan.

Maybe there is no plan whereby investors are willing to buy the majority of debt securitised by U.S. houses. And that's the deep dark secret no one wants to utter in public. These values have to fall by another 20-40% to begin looking reasonable. They cannot be supported these levels. The collapse of complex asset values built on credit is inevitable.

The notion that this is okay, that prices go in cycles and fall as well as rise, is somehow anathema to the modern mind. It's the second reason that governments think they should and can prop up asset values. They believe, absurdly, that cycles are bad and can be avoided with proper policy and stimulus (Friedman-like monetary policy and Keynesian fiscal policy).

This position is both wrong and destructive. Not that policymakers are consciously trying to destroy value. It's just what they naturally do.

When credit creation via global fiat currencies is unchecked (not restricted to available savings or tied to the value of a tangible good), then you get monumental resource misallocation. The decline in the cost of capital leads to a decline in investment discipline (risk assessment) and ethical discipline (Madoff et al). You also get a generation of home and property owners keenly interested in preserving asset values through government intervention just in time to finance a long-awaited retirement.

It's perfectly natural that no one wants to see a lifetime of saving and investment wiped out by falling asset prices. It's not fair. You play by the rules and you expect to get what you have coming. But the nature of fiat money systems is to inflate.

This is not a few fact. It's been evident in previous growth cycles in which credit accelerated returns prior to going bust. It's just the Boomers probably didn't expect the bust to happen in their lifetimes. Yet here it is.

In fact, the sooner this cycle is allowed to operate naturally-destroyed the bogus value on bank balance sheets and liquidating the bad investments of the last ten years-the sooner we can move on to more organic growth. The new will replace the old. Institutions that fail to adapt will be replaced by healthier, better capitalised, and better run ones.

But in the name of "stimulus" and "recovery" and to supposedly correct the excesses of the market, none of the normal free market mechanisms to punish the excesses are being allowed to function. Instead of acknowledging that markets work in boom/bust cycles of progress, excess, and consolidation, today's generation of policy leaders want to eliminate cycles to preserve their fictitious wealth and power!

It won't work. But that won't keep them from trying. More on the stifling effects of stimulus tomorrow. And we promise we'll get to the question of whether economic growth is inherently limited by resource scarcity.

Dan Denning
for The Daily Reckoning Australia

• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Aussie Banks Addicted to Foreign Borrowing
• What a Summer
• NAB Says Big Four Can’t Refinance Property Debt Without Government Help
• Property Sector Has Seen the Value of its Assets Wiped Out

It's been all deficits and wars and big new social promises since then. Officially, the White House reckons the U.S. government will run a US$413 billion deficit this year. It will probably be closer to $500 billion.

Riddle me this, dear reader... who in the world is going to buy the one year Treasury bills? The 6-month bill currently yields 1.63%. The two year Treasury note yields 2.26%. That means a one year bill might yield around 2%, or less than the current rate of inflation.

It is obvious why the Government is doing it. Someone has to pay for all those stimulus checks being mailed out. But who? The Chinese? Sovereign Wealth Funds? Hedge funds? The only reason there might be a market for one-year bills is that no one wants to lend money for a longer period, regardless of the rate.

It's better, you might reckon, than putting your money in a bank that's not been honest about its balance sheet. And it beats owning U.S. stocks, at least for foreign investors, who face capital losses thanks to the declining dollar.

How low has the American government sunk? It's lowered the minimum bid for Treasury's on auction to just US$100, hoping to spur retail demand. But the financing needs are huge. "Over the last several months," says Treasury's Anthony Ryan, "changes in economic conditions, financial markets and monetary and fiscal policy have impacted Treasury's marketable borrowing needs... Financial market strains have impacted the real economy and the nation has experienced lower economic growth, lower receipts and increased outlays."

Are you following this? We have truly entered the state of Ponzi Government Finance. The U.S. government is borrowing money from anyone who will lend it to meet its obligations. Receipts are down... outlays up. Bond issues are on the rise.

To quote the Mogambo Guru, the U.S. dollar is abosolutely freakin' doomed.

In other news, the U.S. Fed cut the target Fed funds rate by a quarter point. We don't really have anything meaningful to say about it. Inflation is loose afoot in the global economy. Fed policy fuels the fires. That didn't change yesterday.

Here's a quick test for you. Beleaguered American bank Citigroup (NYSE: C) is selling another US$4.5 billion in stock to bolster its capital. It's selling 178 million shares for US$25.27 a piece. That was a slight discount to yesterday's closing price, but just one cent below today's closing price.

By contrast, Brazilian oil giant Petrobras (NYSE: PZR) says it plans to issue US$11 billion in bonds this year to help finance the development of its two big recent oil finds (the 7 billion barrel Tupi field and the 33 billion barrel Carioca field.).

Bloomberg reports that Petrobras had to cancel a planned bond offering of $500 million in February because of tight global credit markets. The company says it needs to raise money in the debt markets to finance the capital requirements for its development projects. The company didn't specify the maturity or the yield on the bonds. But Petrobras 2014 bonds currently yield around 5.38%.

So what do you reckon dear reader? In one deal you get equity in America's largest bank. In the other, no equity, and no guarantee that the company will have sufficient cash flow to pay the yield on the bonds (you do have, however, a big honkin' real asset whose market value is immense).

Dan Denning
The Daily Reckoning Australia

• U.S. Treasury Auctioning Off $81 Billion in New Debt
• Mainstream Financial Press is Finally Catching on to Hedge Funds
• China Stepping Up Purchases of U.S. Treasury Debt
• Credit Crunch Is Overpowering Current Investment Banking Model
• Fall in Commodity Prices Will Reduce Inflationary Forces