Of course there is. George Soros is picking up more shares of gold and potash producers. Mineweb reports that, "Billionaire investor George Soros' Soros Fund Management substantially raised its shares in PotashCorp as well as invested in gold ETFs during the third quarter. In Form 13F documents filed with the SEC, Soros Fund raised its PotashCorp from 1.98 million shares to 2.95 million shares with a fair market value of $266.4 million."

And while China and America bicker over currencies, Chinese firms are scrambling to buy real assets. And while Aussie banks source foreign borrowing to lend in local real estate, Aussie mining firms go begging for bits of capital that would bring world-class ore bodies (and key strategic resources) into production...by local producers and owners.

Take Moly Mines. It's aiming to operate a 10 million tonnes per annum copper and molybdenum mine at Spinifex Ridge in Western Australia. Prior to the credit crisis last year, things were going swimmingly. Molybdenum is a hardening agent used in steel-making. There aren't a lot of economic ore bodies in the world. Moly, according to the research we published in April of 2008 in Diggers and Drillers, had one of the most economic deposits.

But it all went off the rails with the credit crisis. The company couldn't secure the funding it needed to bring the project into production. And the share price fell. That made management amenable to any offer that would secure financing and rescue what was still, by all accounts, an immensely valuable and lucrative resource.

Yesterday, the Foreign Investment Review Board (FIRB) approved a $200 million investment in Moly by China's Sichuan Hanlong Group. It gives the Chinese group majority control in Moly and could see the development of the project at Spinifex Ridge begin in the middle of next year.

Good on the Chinese for finding a great project to invest in at a bargain price. The truth is, Australia has more good mineral and energy projects than the local capital markets can realistically fund (given the preference by the banks for investing in/spruikin property). BHP CEO Marius Kloppers made this point yesterday in a lecture to the Lowy Institute in Sydney.

Kloppers said there are 74 separate resource projects worth $80 billion the advanced stages of planning. Those projects need capital. "'Although clearly not simple," Kloppers said, "a part of the solution lies in continued foreign investment, meaning that both Australia and Australian companies need to be open to this kind of investment, despite its immediate and strategic implications."

What are those "immediate and strategic implications?" Well, up to now, existing Australian shareholders are being clobbered. Those who owned equity in these projects before the credit crunch have been diluted as the firms in question raised money with rights issues or institutional placements.

That's fair enough. Owning shares implies an assumption of risk. The stock market is not a savings account. But the other immediate implication is the transfer of majority ownership of these key projects to overseas owners (including the transfer of a big chunk of income from the assets).

This is what it is. And in most cases, it is not an issue of national security. The truth is, many of these projects won't get off the ground without foreign capital. They will create Australian jobs, export earnings, and share price gains for Australian investors. They will also secure key resources for foreign manufacturers.

There's no sense getting all lathered up about it. The status quo is a result of Australia's status as a net capital importer and the investment decisions made with the money Aussie banks have borrowed. The banks could have chosen to invest in Australian mines. But mining is a risky business.

Is it as risky as property? We don't think so. But the way the Australian property market is currently structured - with the government supporting prices directly through grants and indirectly through miserly land releases, and the banks channeling new lending into the market - it's a rigged game for the banks. Why wouldn't they invest in property? It's certainly in their interest.

Whether there is a national interest at stake in the mining industry is another question. You'd certainly think so, given how much government revenue is derived from royalties and exports. But most state governments and the Federal government seem happy with the current arrangement.

The large producers have an unassailable competitive position. And the smaller explorers and developers are left to their own devices to find capital for their projects. Hey...that's why they call it capitalism!

For investors with the patience to investigate the smaller fry, it's a great market. Our new editor of Diggers and Drillers, Alex Cowie, looks like an insomniac in a coffee shop when he comes to the office each morning. There are literally more good stories than he can possibly research.

The important point is that what might be a national problem - selling of mining projects to foreign investors - is an individual investor's opportunity. You always want to invest where you have an advantage. And as an Aussie resource investor looking at the mid and small caps, you DO have an advantage.

Sure, you may be investing alongside the Chinese, who may be getting a better deal. But there are dozens of smaller projects across the resource spectrum that - as long as the world does not plunge into a second great manufacturing depression - make compelling investment stories.

Murray got back to us with his U.S. dollar index chart. You may recall that the other day we published a chart of the dollar index showing that the short-term and long-term moving averages were in danger of crossing. Murray, a full time technical analyst, basically said our chart looked nice but didn't communicate any useful information to traders about when to enter or exit positions affected by the dollar's decline (or rise).

Murray sent over his chart with a note that begins, "The US dollar index is still in strong downtrend. My last update (to Slipstream readers) said that we needed to keep an eye on the 10 week/35 week Moving Average as the confirmation for any change of trend. Also we needed to see a close above around 81 to confirm a re-entry into the distribution between 78 and 89 formed over the last year."

"None of these indicators are close to being confirmed. So, from a long term perspective, you have to remain bearish the dollar although entry into any short positions is highly risky at this point. Have a look at the chart and you can see that the lowest dotted blue line comes in around a price level of 73 which is close to where we are now."

Click to enlarge

"The meaning of the lower dotted blue line is just that it is an area where a false break can occur. So even though the current price action doesn't look like it is related to the distribution between 78 and 89, it still could be so beware. You can see from the other ranges that I have shown in the chart that a break through the low of the range saw a move to around that lower blue dotted line and then saw a squeeze from there. The first one saw a move all the way back to the top of the range and the second one tried to re-enter its range but ultimately failed.

"The point being, if you had sold down at the lower dotted blue line on either occasion you would have ended up in a difficult position. The market usually looks terrible at those points, but all too often you will see a reversal there which will at least move back to the bottom of the range.

"In this case that would see a move back to 79ish. And from there a re-entry into the range could see a quick move to the point of control at 84 and on to the highs at 90. I think we will see the Dollar create a low somewhere between 67 and 74 and then we will see a big short squeeze to take out traders in what has become a very overcrowded trade.

"Don't get me wrong," he concludes. "I still think the US Dollar is toilet paper, but it doesn't mean it won't buck around like a wild bronco on its way to fiat currency heaven."

Yee haw!

Dan Denning
for The Daily Reckoning Australia

• Australian Recession in the Works? Ask the Sharemarket
• The Dark Underbelly of Australia’s Resource Boom: Chinese Resource Demand
• Australian Iron Ore Shares on China’s Menu
• The Aussie Dollar as a Measure of Global Risk Appetite
• Foreign Investment in Australia, How Much is Too Much?

There is a risk in holding cash in an environment of asset price inflation - a condition that usually occurs when governments create large fiscal deficits and inflate the money supply. The practice is endemic to banana republics and declining empires...and it is happening in the US at this very moment.

The global recession and financial crisis have refocused attention on government stimulus packages. These packages typically emphasize spending, predicated on the view that the expenditure 'multipliers' are greater than one - so that gross domestic product expands by more than government spending itself. Stimulus packages typically also feature tax reductions, designed partly to boost consumer demand (by raising disposable income) and partly to stimulate work effort, production and investment (by lowering rates).

The existing empirical evidence on the response of real gross domestic product to added government spending and tax changes is thin... But the evidence is quite strong that these policy responses usually trigger inflation.

I suppose that even someone without any common sense might understand that a "strong currency" over longer periods of time reflects a high degree of prosperity and economic success, whereas a chronically weak currency is symptomatic of economic imbalances, such as a lack of competitiveness or overconsumption, arising usually from excessive supply of money and credit.

I would also suppose that even if someone never travels overseas, he would understand that if the US dollar loses 50% of its value against all the other world currencies (everything else being equal), it means the US is 50% poorer relative to the rest of the world. (Now, this is not entirely correct, since the US has overseas assets that would appreciate in value in USD terms).

Moreover, stock price movements become extremely volatile and erratic in countries with a depreciating currency. In the long run, the depreciation of the currency will usually more than eliminate the gains in local currency terms. So, whereas in 2007 both the Dow Jones and the S&P 500 exceeded their previous highs reached in 2000 in US dollar terms, these indices failed to make new highs in Euro terms. In addition, whereas the US economy expanded in US dollar terms between 2001 and 2007, in Euro terms it actually contracted!

Even with the S&P 500 having shot up since the beginning of the year by over 25%, it has merely kept pace with the price of gold. And during the last 10 years, the S&P has lagged behind the official US inflation rate...while lagging VERY far behind both the euro and gold. Since the end of 1999, the S&P 500 has delivered a total return after inflation of about MINUS 25%.

Unfortunately, the US is not the only country that is busily debasing its currency. "Everyone" is doing it. Because of the current collective debasement of all paper currencies by central bankers, I believe that precious metals and mining companies will maintain their purchasing power.

In the 1980s the US dollar was a very strong paper currency compared to the Mexican Peso. Today, there is no paper currency that is as strong relative to the US dollar as the US dollar was relative to the Peso in the 1980s! The only "currencies" that have a chance of becoming as strong against the US dollar as the US dollar was against the Peso between 1979 and 1988 are precious metals such as gold, silver, platinum, and palladium.

Also, I should add that precious metals could appreciate even if the US dollar miraculously recovered strongly against foreign currencies for an extended period of time. Such dollar strength would probably be a symptom of some horrible economic or political problems around the world, which could be friendly to precious metals.

Central bankers and pundits seem to believe that they have averted the second Great Depression, while ignoring the fact that more and more debt produces less and less GDP and fewer and fewer jobs.

For now, though, the low ten-year bond yield is the lifeline from which all support flows. Much of the investment universe holds together because money can still be had for cheap - not by the volition of a cooperative private sector, rather induced by a US government that simply distributes money for free. Such an ill-conceived idea could only have been born in the test tube of a central banker.

Private lenders comprehend the difficulty of making profits when being forced to lend for nothing, so the government increasingly finds itself to be the interest-free lender of last resort.

Ultimately, if central bankers continue this process for long enough, it is the dollar, and any currency or economy still pegged to it, that could eventually crash. Therefore, we investors find ourselves in the precarious position of having to maintain sufficient liquidity, but not too much in case the real value of these liquid reserves is wiped out by politicians and central bankers gone mad.

Regards,

Dr. Marc Faber
for The Daily Reckoning Australia

• US Dollar As Reserve Currency Not Working Very Well
• 4 Ways to Protect Against a Falling Dollar
• Is Gold Money?
• Gold Falls for Four Straight Days but is the Low Price a Bad Thing?
• Transfer of Wealth

"So what you're saying is that if the Fed leaves rates low, the market basically has permission to rally to new highs, even if they have no basis in projected earnings and stretch valuations even further?"

This was the question we put to our editorial roundtable yesterday. Kris Sayce, Murray Dawes, Alex Cowie, and Shae Smith were all there. The office was hot and sweaty. The air conditioners broke under Melbourne's mild heat wave. But everyone at the table seemed to be in agreement: the Fed has put a rocket under the market.

The conclusion is important to your investment strategy for the rest of this year and probably through half of 2010. The Fed is giving traders as much fuel as they'd like - via low rates - to borrow low and invest high (high yielding assets). The conclusion of the traders, the small cap guys, and the resource guys and gals in our office is that the whole market is going to float higher on a sea of liquidity.

That's just what happened yesterday in New York. The Dow rose over 2% to reach a new 2009 high. The S&P 500 was up 2.2%. And tangible assets like gold and oil surfed higher too. Only the sorry old excuse for a currency, the U.S. dollar, was lower.

Tactically, the editors here at the moon factory reckon that the way forward is up. But it's a dangerous journey. Valuations in a credit boom go out the door. If you participate in this kind of move, you have to be aware that it's liquidity driven (the Fed's liquidity) and not anything else. All the editors agreed to ride it with their open positions, but to initiate trailing stops in all the positions.

Why? The reversals - and they always come - can be brutal. A trailing stop locks in at least some of your gains. So here's a free piece of advice today: set some mental trailing stops on your open positions. No sense in not profiting from a good rally if you are in the market.

If you're not in the market, is now the time to jump in? Will you miss an even bigger upside by staying cautious? Probably. But we reckon that in the longer-term you're better off using moves like this to reduce your allocations to stocks. Sell into strength and get out while the getting is good.

Of course that's a pretty bearish view, not held (or spoken very loudly these days) by too many people. The conventional wisdom is that the stock market really is telling us that the economy is on the verge of a big breakout next year. And besides, stock rallies are always driven by liquidity.

The unconventional wisdom is that the Fed has learned nothing from the last bubble - or is so scared of deflation it's willing to gamble on another bubble in asset prices. The trouble , the eventual bust in asset prices has to be reckoned up. And the Fed, along with all central banks who key off the Fed's policy, are just kicking the can down the road, hoping asset values improve.

But stocks are not engaged in this debate. They are moving up nicely. One sign of a toppy market is an acquisition where the big fish try and eat each other (as opposed to dining on the little, more manageable fish). Yesterday AMP made a $12 billion bid for AXA. That's about all we have to say about that, almost.

Late yesterday afternoon, Kris Sayce sent out a note to Australian Wealth Gameplan readers advising to take a 37% gross profit and sell AXA (ASX:AXA) shares. He recommended the stock as an income play back in June - when we launched the super, income, and safety-focussed letter (as a companion and counterpart to the small cap letter).

Why sell a stock that's giving you capital gains as well as income?

"It's like getting nine months of income in one day," Kris reckoned. And that sounded about right. There will be other higher-yielding stocks on the market (and probably with less risk). Kris isn't changing the income strategy for AWG. But it is a good example of how you can use rallies like this to take profits on existing positions and gradually re-allocate your assets to a longer-term plan.

And speaking of super, the pressure seems to be mounting on the funds management industry to change its compensation model. That will tend to happen when you have two consecutive years of losses and charge people for the privilege. This exposes in plain sight the fact that most funds simply mimic the market (because most funds own the same big cap stocks). When the market drops, the funds go down.

Boom goes the dynamite!

"The reality of a rising market is that many managers generate large fees from general market growth rather than actually delivering out-performance for clients," wrote Frontier Investment Consulting's CEO Fiona Trafford-Walker, quoted in today's Australian Financial Review, under the category of "Gee, you don't say?"

But what's bad for the funds management industry - and end to management fees based on compulsory super contributions - is probably a good thing for investors. We say probably because most investors are lazy and don't want to actively manage their money. It involves thinking, and that competes with watching television, going to the beach, and pruning the hibiscus plants.

For those that do see this as the chance of a lifetime to take more control of super AND get better performance, it means fund managers will have work a bit harder, not just for their money. But for you. And obviously this is good news for the good funds managers. They'll get more business.

And what would a good funds manager recommend right now? Well, we're not running anyone's super. In fact, as an American we don't even have a super fund here in Australia. But we are doing exactly what we recommend to readers anyway: building a position in gold when prices look cheap and being very selective about how many and which stocks to own for this market.

By "this market," we mean one where it looks like another monster low-rate-rally....exactly the sort that preceded the all-time highs in 2007 - right before the reckoning. Once more into the breach...

By the way, we're trying out a new name for our newish offices, "the moon factory." It turns out the building we are now in is an example of Edwardian Freestyle architecture. What's more, historical records show the building has a name. It's called Thalassa.

Wikipedia tells us that Thalassa may be a primordial Greek goddess of the sea, and also a moon of the planet Neptune. The moon options just felt more appropriate than...writing as a primordial Greek goddess of the Sea. That might be interesting too, but what happens in St. Kilda should probably stay in St. Kilda.

Finally, you know you've had a good night when your dinner companion says "Waiter, could we have the cheque and another bottle of wine please?" Former Rude Awakening editor and current US DR editor Joel Bowman was in Melbourne last night with his lovely partner Anya. We joined them for dinner at Fed Square looking over the Yarra, although they had to catch a late flight back to Taiwan, hence the unusual request.

Joel is an Aussie living abroad, while your editor is an American living in Australia. We compare expatriate notes from time to time and talk about the market. We both agreed that the world is an exciting place with lots of opportunity, but probably with more risk than every day Australian and Americans are used to, or, in most cases, financially prepared for.

That's changing. For Australia, it seems to be a positive change. There are lots of income and capital gains opportunities in the Aussie stock market, although being coupled to the Chinese economy certainly has its own set of risks for the next few decades. And there is always the risk that Australia's current prosperity is largely a function of reflated asset bubbles, and thus just as vulnerable as last time (2007).

For Americans, the change is not so positive. The U.S. dollar is a secular decline, yet the American political establishment refuses to accept the fact that nation's finances are in massive disarray. They are either in denial, or just exceptionally stupid, even for politicians. Not surprisingly, their sense of entitlement knows no bounds.

They believe they will be able to keep borrowing from foreign creditors to enjoy a high standard of living. This is the same as saying that the social promises fulfilled with other people's money really are non-negotiable. This isn't high-minded. It's childish.

From our time abroad, we'd say that day of reckoning - where the world's up and coming populations subsidise American consumerism - is upon of us. Has been since 2000 really, when gold became the trade of the decade. The decade isn't quite over yet, and neither is gold's run. But we have a feeling the political, economic, and even military aftershocks from the dollar's decline are just beginning.

Dan Denning
for The Daily Reckoning Australia

• Your Average Australian Super Fund
• Your Actively Managed Superannuation Fund Cannot Beat the Market
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Superannuation Raiding Party Being Formed II
• Is Kevin Rudd Planning to Steal Your Superannuation and Bankrupt Your Retirement?

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

We're back in civilization... Wait...you call this civilization? Looks more like Bubble Land again!

Gold is headed towards $1,100...

Bonds are soft...so is the dollar...

Speaking of old friends, Marc Faber says he's long the dollar. Faber thinks the buck is over-sold. It could rise 10% in this last quarter.

But the Fed says it will keep interest rates low for an "extended period." So there is still no sign of the kind of policy turnaround that might send the greenback back up.

Instead, we'll have to wait until the bubble pops!

Oil is over $80...

Republicans are winning elections...

Hey, party like it was 2006...

The Dow is moving back up, too...and so are all the world's markets...led by Asian stocks. China is booming...with its stocks up 4 days in a row...

The rise in gold comes as India's central bank does the smart thing. Central banks need reserves. And historically, the only reserve a central bank can trust is gold. Putting US dollars in your vault - instead of gold - is a little like laying in a supply of lettuce to tide you over in a bad harvest year. Imagine what would have happened if pharaoh had stocked up on radicchio instead of grain? Those 7 lean years would have been a lot leaner than they were.

The Chinese have seen what happens when you rely on dollars for a reserve. You're stuck. Because your reserves can wilt fast.

The Indians have a better idea - they're buying gold.

The metal has outperformed stocks and bonds this year as it heads for the ninth straight annual gain. The Standard & Poor's 500 Index has risen 15 percent in 2009 through yesterday while returns on the benchmark 10-year US Treasury note are down 5.7 percent.

Gold may average $1,125 in 2010, "with strong investment demand anchored by a negative real-interest-rate environment and probable central bank purchases," analysts at Toronto-based Desjardins Securities Inc. said in a report.

And here's another interesting item we found when we got back to an Internet connection: "Companies that become too big, complicated and debt-ridden should be allowed to 'creatively destruct,'" says our friend Nassim Taleb, author of The Black Swan.

Taleb likens the process to natural selection. "Why is it that there are no land animals bigger than an elephant?" he asks. "Because nature doesn't permit it. Bigger animals die off. Likewise, the market system disposes of companies that are 'too big to fail.' It gets rid of them."

Unfortunately, says Taleb, the US government is impeding this natural process. The government is preventing the bankruptcies of large corporations that would clear the way for a new generation of healthier, more nimble, corporate organisms. Furthermore, these trillion-dollar bailouts are polluting the financial ecosystem with toxic piles of debt.

"We're not destroying debt," Taleb complains. "When you move it into the government, it stays in the government and that's a problem."

Bill Bonner
for The Daily Reckoning Australia

• Naturally the Feds Want to Raise as Much Money as They Can
• Life Goes On
• There is More to Wealth than Money
• Global Credit Shortage is Over According to European Central Bank
• Central Banks’ New Money is Piling Up

The kind people at Stratfor sent us a note informing of us such, but granting us permission to use it nonetheless. We sent them a note abjectly apologising for the mistake and thanking them for letting us use it. We've been a bit touchy on that issue ourselves lately. It was a great chart and they made a great point with. So if you're into that kind of macro-political analysis, tool over to the Stratfor website for a look.

So how about the Fed? It's carried on with its wayward monetary policy. And it's carried on with the carry trade by keeping short-term rates low.

In deciding to make hardly any changes to its interest rate policy or even the language from its last statement, the Fed is encouraging traders to resume the dollar carry trade. For now, it looks safe to borrow in low-yielding currencies like the U.S. dollar and invest in higher-yielding assets like the Australian dollar, emerging market stocks, and some bonds.

Go you bubble beauties!

It's hard to believe the Fed is wilfully stupid. The market, through the price of gold, has clearly communicated that it thinks U.S. monetary and fiscal policy is lousy. But rather than defend the U.S. dollar - indeed the integrity of U.S. monetary policy itself - the Fed is choosing to support asset prices through easy credit.

It's also possible that the Fed thinks a weak dollar will reduce America's trade deficit, boost its export competitiveness, and lead to higher employment. We think this is a pipe dream. And we're not talking about a lead pipe. We're talking William Blake-style opium.

But smoke and mirrors aside, does this mean we were wrong about our call last week for the end of the dollar carry trade? If the U.S. dollar index rallied, we expected to see a falling Aussie dollar, falling Aussie stocks, and (even though it's strange) rising U.S. bond prices. All the leveraged risk trades would unwind a bit as dollar shorts covered.

But now what? Is this the all clear for stock indices to make new highs as traders borrow money and plow it into markets to engineer huge returns for the end-of-year statements to investors? The early returns are inconclusive. The Dow was all over the shop, unable to make heads or tails of what the Fed's non-change means. Gold futures made a new nigh, though. And about that...

Gold is very popular lately. It's not returning our calls anymore. And when we see it in public, all it does is glitter and bask in the glow of so many new found admirers. That makes us very nervous, and perhaps a bit hurt. We stood by it all those years when no one loved it.

We like it all the same, although we're just friends now and it's based on gold's ability to preserve the purchasing power of our wealth, not any inherent beauty it may or may not have. But as a practical matter, when you enter a position as the asset is making a new high, you usually get hammered.

That's what happens when you go along with the crowd. It's an axiom that an asset has to make new highs...to make new highs. But it would be nice to buy gold on a correction. Perhaps, though, we are seeing a big shift in market psychology with respect to gold. India's purchase of IMF gold, as we reported yesterday, is just one sign of that shift.

One interesting result from the events of 2009, Murray Dawes mentioned last week, is that gold is decoupling from the U.S. dollar. He sent over the chart below. It shows that two times in the last five years, gold (the black line) has strengthened eve as the U.S. dollar index (the blue line) rallied. And each time after this period of dollar strength, gold then took off to a new move up.

Click to enlarge

Why does that matter? Well, gold usually moves up when the U.S. dollar moves up, and down when the U.S. dollar moves up. For gold to show strength when the dollar is strong shows that gold itself may be breaking out of its correlation to the greenback. And what would that tell you?

For traders, Murray is showing that the movement of the U.S. dollar is what Aussie stocks are keying off of. Thus, knowing where the dollar is headed tells you whether you should be long or short Aussie stocks (as a trader). Murray is sorting which stocks specifically are there for the trading (and in which direction).

But in the bigger picture, gold breaking its negative correlation with the USD would tell you that gold is being remonetised in the world financial system. It would tell you gold is appreciating against nearly all paper currencies. And it would tell you that even if we do see a U.S. dollar rally, you could still new highs in the gold price. You may also see gold break out in a major way in Australian dollars.

Above all, it shows you how valuable it is to own an asset that is not anyone else's liability. We are entering a global sovereign debt crisis because the world's large economies have been engaged in a multi-decade long competition to devalue their currencies. The cheaper your currency is relative to your trading partners, the cheaper your goods are and the higher your exports.

Overly the last fifty years, nearly every country in the world has engaged in some kind of currency manipulation to keep its currency cheap relative to the American dollar. That's because the American economy was the world's largest, and everyone wanted to sell into it.

America's economy is still big, of course. But a lot is changing, yet the currency manipulation has not caught up with the new economy reality. And Western Welfare states are still borrowing money as if emerging market creditors will be happy to fund fundamentally flawed fiscal policies for ever. Not likely. But tomorrow is another day. Until then...

Dan Denning
for The Daily Reckoning Australia

• Prices of Gold in the Top 10 World Currencies
• Gold, the Aussie Dollar, the Greenback and You
• Trouble In Tokyo
• Aussie Dollar is Crushing Long-time Rivals Like the Pound and the U.S. Dollar
• More Money in Cash Right Now Than Equity in U.S. Companies

If you want to attend the presentations and discussions over the next four days, you can still do so. But you should contact conference organiser Marcus Matthews today. You can reach him via email at feketeaustralia@gmail.com. And if you're there on Sunday, be sure to say hello.

Yesterday we promised to show you how the funding model for the fiscal welfare state is blowing up. But this is going to have to wait at least another day. Don't worry though. It's not going anywhere.

Today, there is a banking story to cover. You recall that yesterday we were worried about the next banking crisis. But the lingering effects of the last one are still with us. National Australia Bank reported a 43% fall in net profit yesterday. Ouch.

Don't feel too bad for NAB. Net profit fell from $4.54 billion to $2.56 billion. But the bad and doubtful debts charge for the year grew by 53% from $2.49 billion to $3.82 billion. With $654 billion in assets and $616 billion in liabilities, the bank is sitting on $37.8 in equity. A few billion in bad debts and loan losses won't wipe out that amount of equity.

But it's worth noting that NAB's total assets are 17.3x times equity. This isn't as high as some leverage ratios in the U.S. just prior to the banking crisis in 2008. But it's not far off where NAB was at the time. And there are two further risks worth mentioning.

First, as the IMF paper on Aussie banks concluded earlier this year, Aussie banks are probably strong enough to withstand a normal shock to the balance sheet. That is, the IMF stress-tested Aussie banks for losses on their two largest loan portfolios - corporate loans and mortgages. The IMF concluded the banks were adequately capitalised to survive the shocks it tested for, but that, "The above shocks do not constitute a rigorous stress test and the results are only indicative of the health of the banking sector."

If we've learned one thing in the last two years, it's that bankers and analysts have consistently underestimated the frequency and magnitude of systemic shocks. That doesn't mean the IMF conclusions aren't to be trusted. But it means in the event of another more severe shock, the banks could face larger asset writedowns and losses than the IMF has modelled.

This brings us to the second risk worth mentioning. A bank facing bigger loan losses takes fewer risks. It reduces lending. This is how the credit crisis was transmitted from America's housing market to Australia's economy. The Aussie banks had to tighten up to prepare for losses on overseas assets.

Next time around, though, we reckon the losses - when they come - will be on domestic real estate assets. And with so much exposure to domestic real estate (mortgage loans), the assets could face a world of hurt. But even if bank asset quality doesn't crash (housing prices don't crash), an external shock affects Aussie bank liabilities.

The IMF report says that, "On the liabilities side, however, banks had sizable short-term external debt obligations, and access to offshore wholesale markets was disrupted by the Lehman Brothers collapse in September 2008." Of course the government's wholesale funding guarantee eased the pain of this shock, which is one reason why that guarantee may become permanent in all but name.

But the IMF wrote that, "A key remaining vulnerability is the roll-over risk associated with sizable short-term external debt. Banks' wholesale funding (domestic and offshore) accounts for about 50 percent of total funding, of which about 60 percent is offshore. Financial institutions short-term external debt (on a residual maturity basis) is estimated by staff at about $A 400 billion (35 percent of GDP) in March 2009."

Maybe the short-term external debt levels have improved in the last six months. We haven't checked yet. But in simple terms, it means a lot of domestic lending is funding from external funding, borrowing abroad to loan at home. If American banks again blow up on the destruction of their remaining collateral (mortgage loans and U.S. Treasury bonds) we'd predict another ice age in global credit markets.

Needless to say, as a capital importer, this would put Australia in an awfully uncomfortable spot. But hey! No one is worried about that at the moment. The Aussie dollar is being inflated by the U.S. dollar carry trade. It's a shame that the strong Aussie is going to devastate local industry and manufacturing with higher costs, but at least it obscures for now the risk that Aussie banks are reliant on foreign borrowing.

In the bigger picture, this means the investment needs of the economy can't be met by household savings alone. But that's an even bigger problem than we can address today. So we won't!

More cow bell!

And what about our theory that a U.S. dollar rally will trigger a correction in gold, oil, and stock markets and lead to a mini-rally in U.S. Treasury bonds? Bond fund king Bill Gross agrees. Writing on Pimco's website, Gross concedes, "Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets -- while still continuously supported by Fed and Treasury policy makers -- is likely at its pinnacle."

Dr. Doom himself, analyst Nouriel Roubini, called the present market "The mother of all carry trades." "This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals," Roubini said via satellite to a conference in Cape Town, South Africa. "The risk is that we are planting the seeds of the next financial crisis."

With the S&P up nearly 65% since touching 666 in March (seriously), we'd say the seeds are already bearing fruit. But maybe it's poisoned fruit. After all, the rally has been worldwide and extremely impressive by historical standards. But it's fully consistent with previous bear market rallies. If anything, it's happened faster.

What nobody yet knows is if it IS a bear market rally...or a garden variety stock market rally that precedes a recovery in the economy. You know what we think.

There IS one notable difference between 2008 and today, though. Yesterday we mentioned that U.S. banks have loaded up on a whole other kind of super-dodgy collateral; U.S. Treasury notes and bonds. Demand for those securities may go up with a U.S. dollar rally and a reversal of the dollar carry trade. But in the longer-term, we think the banks have invited another toxic house guest on to the balance sheet.

But where did the previous smelly houseguest go? You know, all those mortgage backed securities and subprime loans? Where does that risk now reside? And what happens if it comes home to roost?

According to this report by the San Francisco Federal Reserve, over 95% of all new residential mortgage lending in the U.S. is now being backed directly by the U.S. government. With the banks unable or unwilling to lend, Uncle Sam has become the sugar daddy of the U.S. mortgage market. See the chart below.

The Fed supports this market by purchasing the securitised mortgages issued by Fannie and Freddie. The Congress funds the agencies which make the loans available. But no matter how you slice it, the U.S. government is supporting the housing market. It will continue to do so as a political imperative.

But by taking on this massive liability - not that it doesn't already have its hands full - the Fed is further consigning the dollar to the scrapheap of history. Do you think foreign creditors will not realise that the U.S. is borrowing money to keep house prices elevated? Will they not notice that the U.S. is printing money to do this? And what will happen to the dollar then? And gold?

The truth is that creditors already do know this. Today's Australian Financial Review reports that overseas Chinese investment is "surging." Chinese policy makers are trying to trade dollars for tangible assets or equity in resource shares as quickly as possible. "China reported a 190% jump in overseas investment by its companies for the third quarter."

"Policymakers might be encouraging Chinese firms to invest abroad, in part to help counter pressure for the nation's currency," the article continued. "Investors are betting on the yuan to appreciate as China's growth accelerates from its weakest pace in a year."

Most currencies that are not the U.S. dollar could appreciate in the coming years. Australia's currency has already done so. Brazil is considering a tax on capital flows into the country in order to prevent investors from speculating on a further rise in its currency by buying Brazilian assets. And of course speculators have tried for years to find a way to position themselves for an appreciation in China's currency. China's capital markets are not friendly in this regard, although Hong Kong stocks remain a popular option.

The fact that countries like Australia, China, and Brazil are trying to limit currency appreciation versus the greenback shows you how unbalanced the world economy still is, how unprepared it is for the reality that America's deleveraging will take place for years. Households and businesses must save and repair balance sheets. Some other country is going to have to consume what the world produces.

In the interim, the U.S. government will increase deficit spending to make up the difference. It is the stupidity of Keynesianism to support aggregate demand when what everyone needs is a correction and a recovery. But all the Feds will succeed in doing is blowing up the balance sheet of the U.S. government in spectacular fashion. Go gold.

Mind you we still think the short-term move is a dollar rally and some profit-taking on the dollar carry trade. We asked Slipstream Trader Murray Dawes what he sees when looking at the U.S. dollar index. Murray spends most of his time finding trading opportunities in Aussie stocks. But he also knows that Aussie markets (and capital flows) are still massively affected by what's going on in America.

Murray wrote that, "If we look at this chart of the US Dollar index going back to 1985, you can see quite clearly that the 10 week moving average crossing over the 35 week moving average has been a very good indicator of the trend. There are only a few instances over that whole time period where this indicator gave a false signal."

Click to enlarge

"Therefore," Murray continues, "we should be keeping an eye on this indicator going forward to tell us whether the US Dollar index has turned back up and is ready for a counter trend rally. The short US Dollar trade is getting pretty full, as I have mentioned in the past. And there is a high correlation between the direction of the dollar and the direction of gold, oil and stocks.

"The US Dollar has taken over the Yens role of funding the carry trade and this will be the situation for as long as the Fed remains too scared to raise rates, which seems to be for the foreseeable future. So we can probably expect the dollar to weaken further over the long term, but a counter trend rally (short squeeze) may be closer than people think and this would lead to weakness in commodities and stocks.

"When should we trade this move? Well have a look at the chart again. Notice the false breaks that keep occurring when the all time lows get breached (denoted by the numbers 1,2,3). With the trend still strongly down we can expect to see either a false break of the lows around 71 reached last year or if that doesn't occur then a crossover of the 10 week/35 week moving average to confirm that the trend has changed. Trading the move before either of these are confirmed would be jumping the gun."

Murray is tracking which Aussie stocks will move if and when we see the dollar index break out. We'll keep you posted.

Dan Denning
for The Daily Reckoning Australia

• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• IMF Report Concludes Aussie Banks are “Very Sound”…
• A National Mortgage Bubble
• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?

But a warning about what? Sure, stocks, oil, and gold were all down yesterday and the U.S. dollar was up. But is it really the end of the dollar carry trade? And if it is, what happens next?

More cow bell!

We should back up a second. What is the dollar carry trade? It's the engine of bank profit growth this year. It's what's given the illusion that the financial system has recovered from its brush with death last year.

But as you'll learn today, the bankers, the Fed, the media...the whole lot of them...have learned nothing from last year. The hangover was just beginning to set in, so everyone began drinking again heavily. And now the party is wild and out of control. Even the cops are drunk.

Incidentally, this complete abandonment of monetary sobriety and fiscal prudence shows up every day in real life, where the declining value of money is paralleled by a general decline in public behaviour. For example, on Sunday morning we were tucking into a breakfast of banana caramel pancakes (with a scoop of vanilla ice cream on the top) when three incredibly drunk but fairly well dressed middle aged men had a seat next to us at the cafe.

They wanted to chat about the John Birmingham book on the table. They wanted to smoke. They wanted to laugh, and did so loudly to the point where they began upsetting the various dogs assembled in the sun. They ordered a pitcher of beer. They were served. It was 9am and they hadn't been to sleep.

Our cow bell tells us that the financial party thrown by Ben Bernanke may soon be ending. The dollar carry trade, by the way, is where financial firms and speculators borrow cheap money in the U.S. and use it to buy higher yielding assets elsewhere (like the Aussie dollar).

The carry trade is a bubble enabler and balance sheet stabiliser in the short-term. The Fed keeps rates low, the banks borrow and then buy U.S. bonds (which helps the U.S. fund its deficit), buy stocks, and buy commodities. The dollar carry has fuelled the world-wide rally more so than any phantom recovery in the real economy, where employment hasn't recovered and wage growth is hard to find.

What the carry trade has not done is fundamentally improved the balance sheets of the very financial firms that were at risk of insolvency last year. Why not? First, the earnings rebound in the first three months of the year was not driven by better business conditions. Speaking to the Financial Times earlier this week, George Soros said, "Those earnings are not the achievement of risk-takers...These are gifts, hidden gifts, from the government."

The banks booked profits from trading stocks and bonds. And because the Fed, through quantitative easing, was supporting bond prices directly, it was as close to free money/a rigged market as you can get. With enough leverage, even small gains in bond prices were bankable.

But now there is an enormous, gut busting irony to the position the banks find themselves in. Remember that the original idea to repair bank balance sheets and restore their capital positions to healthier levels was to replace toxic mortgage-backed debt with safe, sound, and liquid U.S. Treasuries. Snort. Guffaw.

The irony is that those same Treasuries could be the next big blow up, wiping out the banks thin equity capital sliver all over again, and plunging the financial sector into a second wracking round of forced deleveraging and asset sales. Round two of the recession, morphing into a Depression as the public sector ramps up deficit spending to make up for the collapse in household and business spending.

We all know how much serious the cycle of deleveraging and asset sales was last time around, so it's not a claim we'd make lightly, or without some evidence. So let's get to the evidence. First is an article from Gillian Tett, also in yesterday's FT, titled "Rally fuelled by cheap money brings a sense of foreboding."

"Earlier this month," she begins, "I received a sobering e-mail from a senior, recently-retired banker. This particular man, a veteran of the credit world, had just chatted with ex-colleagues who are still in the markets - and was feeling deeply shocked."

" 'Forget about the events of the past 12 months ... the punters are back punting as aggressively as ever,' he wrote. 'Highly leveraged short-term trades are back in vogue as players ... jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds.'"

" 'Oh, I am sure the banks' public relations people will talk about the subdued atmosphere in banking, but don't you believe it,' he continued bitterly, noting that when money is virtually free - or, at least, at 0.5 per cent - traders feel stupid if they don't leverage up.

" 'Any sense of control is being chucked out of the window. After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months,' he added. He finished with a despairing question: 'Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?'"

This 'latest bubble' is in evidence across all asset markets-bonds, stocks, commodities, property, and cash. Free money does not discriminate on the basis of asset class. But nowhere has the bubble been more generous than in the U.S. Treasury bond market. Short-term U.S. bond yields are vanishingly low. The Fed just purchased $14 billion more in mortgage-backed securities last week and now holds $776 billion in MBS and $773 billion in Treasuries. All up, the Fed's balance sheet is at $2.1 trillion.

But here is the thing: the Fed says it's ready to end its program of buying Treasuries and MBS. It realises it will have its hands full funding big U.S. deficits. But if the Fed withdraws its support for bond prices...you can expect bond prices to fall and yields to rise. This may happen even if the Fed keeps buying bonds...but creditors like the Chinese and Japanese stop (as they have done with agency securities.)

All sorts of interesting things begin to happen now, if by interesting you mean terrible but fascinating. Falling bond prices and rising yields would make perfect sense in a U.S. dollar rally. And a U.S. dollar rally makes perfect sense if the carry trade ends and the dollar shorts cover. Speculators take profits in oil, gold, stocks and jump back into cash and the greenback. This is roughly what happened last time the wheel's came off the financial system.

Where does that leave banks and their massive new hoards of U.S. Treasury bonds? An article called "Bank Insolvency Is Not A Dead Issue" by Daniel Aaronson and Lee Markowitz shows that banks have dramatically increased their holdings of U.S. Treasury securities. When you add their existing exposure to U.S. real estate (facing an Option-ARM crisis over the next twelve months) you have a huge swathe of bank collateral that could face another massive write down.

What do you think that might do the global economy? Aside from putting a few more banks out of business, it would again cut off the flow of credit to small businesses and the rest of the economy. It might again cut off the flow of bank credit from international lenders to the Big Four here in Australia. And this time, what kind of aid can the Feds really offer when their last attempt at help (exchanging Treasuries for RMBS) set the banks up for precisely the implosion they were trying to avoid?

As you can see from the chart above, banks have grown assets again with the Fed's borrowed money. You know have a freshly steaming pile of recovering asset prices supported by a thin wafer of equity capital. It's a fraud with a cherry on top. As the charts below, U.S. banks own nearly $1.5 trillion in government securities. And they are gobbling them up like there is no tomorrow.

There is always a tomorrow. But corporations and institutions live and die just like species. Only the earth abideth forever.

We reckon that the entire financial industry is still dangerously close to a species-destroying event. It's leveraged model of asset growth and debt accumulation imploded last year. But the Fed has brought it back, and like a Zombie/Frankenstein mash-up, it's here to torment us all again.

Soros told the FT this sequence of events is causing a lack of confidence in governments. "There is a general lack of confidence in currencies and a move away from currencies into real assets," he told the FT. "There is a push in gold, there's strength in oil and that is a flight from currencies."

So in the short-term, don't be surprised to see a stronger rally in the USD, which would take some of the starch out of oil and gold prices. As the dollar carry trade unwinds a bit, stock markets will fall and so will other asset classes that have zoomed up on the speculation.

But the bigger story playing out is this: the entire method by which the fiscal welfare state funds itself is blowing up. More on how this will happen and what it means tomorrow. Until then, we hope you heard the cow bell.

Dan Denning
for The Daily Reckoning Australia

• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• Fed Announced it Would Buy up to $300 Billion in Treasury Bonds
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position
• The Only Thing Really Going Down Right Now is the U.S. Dollar

Much will be revealed this week in the Aussie market, although a lot will probably remain obscure too. Producer price data for the September quarter comes out from the Australian Bureau of Statistics. Inflation anyone? Maybe not in wages. But certainly in raw materials (energy).

And speaking of inflation, the Housing Industry Association will report new homes sales data for September later this week too. What do you reckon it will show? Our prediction: how prices in Australia are outrageous and getting more so with each passing month, as the banks double down on home lending.

You may even see a move in the Aussie gold price this week. It could come if the U.S. dollar pulls itself together for a bit of a rally, as we're expecting. But the other reason Aussie gold may go up is a small item on the front pages of today's Australian Financial Review. "Big Banks gear up to lend again," reports the AFR. Uh oh.

No one's been too terribly worried about consumer price inflation lately, mostly because it's been masked - until recently - by cheaper oil prices. Of course the biggest factor affecting consumer price inflation is the growth in bank credit. The RBA reports on that later this week. But bank lending is the main engine for new money creation in the economy...and new money creation is the main engine for inflation.

"The Big Four banks are keen to lend more aggressively to large businesses as the economy recovers and competition for assets intensifies, in a development that is likely to drive down corporate borrowing costs," Katja Buhrer writes. "The major banks are seeking to take advantage of surplus capital and improving corporate growth prospects."

Hang on! Surplus capital? Just last week we were under the impression that Aussie banks were having to import capital from foreign lenders in order to fuel the housing bubble. Now there's surplus capital? And now the banks are eager to loan it out and build up the asset side of the balance sheet again?

So much for deleveraging in the financial economy! This sounds like re-leveraging. It also sounds like exactly the sort of thing - a fresh new wave of bank lending into the real economy - that could trigger much larger inflation. This is the sort of thing the RBA is trying to prevent by raising rates. But if banks start expanding the asset to capital ratio again, watch out! You could see higher Aussie interest rates AND a higher Aussie gold price.

"West Africa beckons as Aussies go for gold," reports Barry Fitzgerald in today's Brisbane Times. This answers a basic investment question: which Aussie gold producers benefit most from a rising gold price and a strong Aussie dollar? ASX-listed firms with greenfield West African gold assets generally have their costs in U.S. dollars. That's a big advantage over domestic gold producers.

Dan Denning
for The Daily Reckoning Australia

• RBA Rate Cut Does Little to Unlock Credit Market
• Global Credit Shortage is Over According to European Central Bank
• Australian Recession in the Works? Ask the Sharemarket
• Foreign Investment in Australia, How Much is Too Much?
• Banks or BHP?

The dollar has been the "Coca-Cola of monetary brands," says James Grant, editor of Grant's Interest Rate Observer. But even the best of brands can be lousy investments. Grant uses the analogy of The New York Times. It was the greatest name in newspapers. In 2002, the stock sold for $53 per share - an all-time high, as it turned out. Today, the "Gray Lady" fetches only $8 per share.

"What happened?" Grant asked. The World Wide Web happened, he says. "The Times has hundreds of reporters, but this is a story they seem to have missed." As if the lowly stock price was not evidence enough of its decline, the NY Times got another reminder when it borrowed $225 million against it headquarters building. The cost of such borrowing, Grant reports, was 14%. The august Times today borrows at rates no better than a working-class stiff at a pawnshop. The US Treasury should take note. The government seems as intent on creating dollars as prolifically as bunnies create other bunnies.

Here we get to John Paulson, a presenter at the Grant's Fall Investment Conference and undoubtedly the richest man in the room. Portfolio magazine dubbed him "The Man Who Made Too Much" after he made $3.7 billion by betting against mortgage-backed securities (MBS). He is one of the greatest hedge fund managers ever.

Gold is his favorite today. As to why, Paulson presented a simple, but compelling case. First, the monetary base has exploded in a way we've never seen before. The monetary base is essentially the Federal Reserve Bank's currency and reserves. The Fed, by buying up securities in this crisis, has pumped a lot of money into the economy.

You've probably seen this chart, or some variation of it. Still, there haven't been noticeable signs of inflation as a result of that big spike - not yet.

As Paulson explained, that's because this base money has not yet been lent out and multiplied throughout the economy. Yet the monetary base and money supply are highly correlated, "almost 1-to-1 between the two," Paulson said.

That means that as the monetary base expands, the money supply surely follows, though there is a lag. (Money supply is a broader measure of money than just the monetary base, as it includes personal deposits and more. The monetary base is like a kind of monetary yeast. It makes money supply rise.)

If money supply grows faster than the economy, that will create inflation, says Paulson. As it is impossible for the economy to grow anywhere near that vertical spike in the monetary base, Paulson contends inflation is coming.

The US is not alone in its money-printing exercise. The supply of most currencies is expanding rapidly - even the normally tame Swiss franc. In the race of paper currencies, they are all dogs. Hence Paulson's interest in gold, which no government can make on a whim.

Therefore, in the content of the exploding monetary base, gold seems relatively cheap. In other words, as the money supply rises, so does the price of gold, eventually. As a result, says Paulson, "gold has been a perfect hedge against inflation."

There is some slippage over time. The gold price can change faster or slower than the money supply. But when the market gets worried about inflation, the gold price usually changes much faster - as happened in the 1970s. In 1973 - to pick a typical year - inflation was 9% and gold rose 67%. That was a pattern common in the 1970s.

The potential for inflation this time around is greater than it was in the 1970s, given that the growth in the monetary base is so much greater than it was in the 1970s. Gold could do much better this time around, reaching "$3,000 or $4,000 or $5,000 per ounce" as Paulson said.

I keep thinking how future historians will look back at the present day and see clearly how this unfolded. They will see the litany of news items that pointed to the dollar losing its top perch: China and Brazil settling up trade in their own currencies. The Russians and others openly calling for a new monetary standard. Even mainstream outlets are discussing alternatives to a dollar-based standard, a province once solely occupied by cranks and gold bugs. Not a week goes by without these kinds of stories.

As for a replacement waiting in the wings, Grant offers up gold. Indeed, a kind of "de facto gold standard" seems to be taking shape. The SPDR Gold Trust, the largest gold-backed security in the world, is now the sixth largest holder of the metal in the world. Anybody with a brokerage account can easily buy gold today through the trust, which trades on the NYSE under the ticker GLD.

It's still early. Most people still own no or very little gold. As it becomes clearer what's happening, they will buy more gold, especially as it is now easy to do so.

The gold supply, too, is limited against the vast pool of dollars. As Paulson points out, global money supply is 72 times the value of gold. I'm betting that gap will narrow. It only has to narrow a smidgen and the gold price flies.

As Grant eloquently put it: "Gold is a speculation. But it is a speculation on a certainty: the debasement of the currency." Gold stocks, too, are a speculation. But they are a speculation on an inevitably higher gold price.

Regards,

Chris Mayer,
for The Daily Reckoning Australia

• Dollar Rally the Sort of Thing that Will Lead to Correction in Gold Price
• A Gold Standard, Without Gold
• US Dollar As Reserve Currency Not Working Very Well
• The Destruction of the Dollar by the Federal Reserve
• Fannie and Freddie in a Free Market Economy