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

It's becoming a bit of an obsession we admit. Interest rates are the last thing we look at before bed and the first thing we look at in the morning (even before coffee). They have made for compelling viewing in the last month. And oh what a story they are telling about the decline of Empire and the rise of...something else.

For a change, it was not just ten-year U.S. bond yields rising on Monday, although they were up to 3.89% as bond prices fell. Even the little old two-year notes are facing rising yields. The yield on the two-year U.S. note rose 11% to 1.42%.

These little cracks in the bond market are like the first small fractures in a plate glass window. Investors have a look at large government deficits everywhere and the fracture gets deeper and wider and leads to other cracks.

Central banks begin quantitative easing policies to buy up debt (some corporate, some mortgage-backed, and some which is their own cooking) and then you see the whole window blossom into rivers and rivulets of cracks, both beautiful and highly unstable at the same time.

And then someone comes along with a hammer, taps the pane gently, and the whole thing shatters like so much glass.

Of course, long-term bear markets in an asset class don't always happen so suddenly. They begin with a reversal (which rising yields indicate), and then they fight conventional wisdom, losing an occasional battle. Today, for example, the U.S. dollar managed to rally a bit, while gold and oil fell.

But we think the early votes are in on the new trend in the market: sell bonds and buy commodities. It's an inflation preparation strategy.

And why inflation? The proposed global deficits to combat the recession and the sickly credit markets are simply too large to be funded by private investors. "It is obvious that the Chinese and other surplus nations cannot fund the [U.S.] deficit even if they were fully on board -- which they are not. Someone else has got to write checks for up to $1.5 trillion additional Treasury notes and bond," writes Pimco's Bill Gross.

"The concern is that this can be accomplished in only two ways -- both of which have serious consequences for U.S. and global financial markets. The first and most recent development is the steepening of the U.S. Treasury yield curve and the rise of intermediate and long-term bond yields. While the Treasury can easily afford the higher interest expense in the short term, the pressure it puts on mortgage and corporate rates represents a serious threat to the fragile 'green shoots' recovery now under way."

"Secondly, the buyer of last resort in recent months has become the Federal Reserve, with its publicly announced and near-daily purchases of Treasuries and agencies at a $400 billion annual rate. That in combination with a buy ticket for over $1 trillion of agency mortgages has been the primary reason why capital markets -- both corporate bonds and stocks -- are behaving so well. But the Fed must tread carefully here. These purchases result in an expansion of the Fed's balance sheet, which ultimately could have inflationary implications. In turn, nervous holders of dollar obligations are beginning to look for diversification in other currencies, selling Treasury bonds in the process."

Gross finishes with this advice: "Bond investors should, therefore, confine maturities to the front end of yield curves, where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same. All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago."

Got that? Be in short term bonds. Sell the dollar. Own commodity-based currencies (actually Gross doesn't say that, but we do!). And reduce your expectations for total returns. Not very cheerful, is it?

Gross may be underestimating the amount of money punters can make in small resource exploration shares. That's probably because he manages billions of dollars. That keeps him in the fixed income market. He is too big a player to have a punt in small Aussie resource shares.

But we know that inflation fuelled rallies benefit smaller commodity stocks the most. And fortunately, there is no shortage of investment ideas or speculative bets in Australia. If you had to live in a world where investment returns were expected to be lower for awhile, you'd want to be in the one market where the returns on offer are still pretty double-digit looking. That's Australia.

Whether those returns materialise will depend on our good friend China. And according to some reports this weekend from China's official Xinhua news agency, Australia had better send flowers to Beijing soon, or at least chocolate. And probably an apologetic text message over this whole Rio business. A teddy bear wouldn't hurt either. With a big red bow.

Dan Denning
for The Daily Reckoning Australia

• Fed Willing to Print Money to Buy More Bonds to Keep U.S. Interest Low
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• Consumer Price Inflation has Spooked Investors Everywhere
• Fed Announced it Would Buy up to $300 Billion in Treasury Bonds
• Between What Bond Investors Stand to Gain in Yield and What They Stand to Lose from Inflation

Of course, there is no need to exaggerate. The facts are outrageous enough. So, let's calmly look at what has happened so far...and where it is likely to lead.

As you know, the battle between inflation and deflation is going badly for the feds. Deflation is winning. And yesterday, the Eastern Front collapsed.

Germany announced that consumer prices are now 0.1% lower than they were a year ago. Germany is in outright deflation. The rest of Europe is probably not far behind.

In America, the trend is probably in the same direction. The money supply - M1 - grew at an 18% rate over the last 6 months. But taking just the last 3 months, the rate of growth has fallen to only 1.8%.

Meanwhile, the US Treasury is borrowing hundreds of billions' of dollars in order to close the gap between what the US spends and what it receives in taxes. Even if the Chinese are willing to fund that borrowing in the very short term, it just pushes forward the inevitable daywhen the list of willing lenders is shorter than the list of US Treasury bonds to be sold.

When that happens, the Chinese can bend over and kiss their reserves goodbye. Because there is no way the US government is going to forego spending money just to protect foreign bondholders. Instead, to raise money, it is going to turn to its very own bond buyer of last resort - the Fed.

The Fed will "monetize the debt" - by buying Treasury debt and converting it to dollars in circulation. At least, that's the plan. The risk is that it will cause consumer price inflation. Everyone is aware of the risk. Few doubt that it would happen.

But that's where Gono, Rogoff, Mankiw and many others, come in.

Caroline Baum reports:

"Harvard University's Ken Rogoff and Greg Mankiw think more is better when it comes to inflation.

"Rogoff said he advocates 6 percent inflation 'for at least a couple of years.' That would alleviate the strain deflation imposes on debtors, including the U.S. government, who have to pay back their loans in appreciated dollars.

"In the Middle Ages, they threw people who failed to repay their debts into debtors' prisons. Today debtors are rewarded with all kinds of government perks. Look how far we've come!

"Borrowers took out mortgages they couldn't qualify for to buy homes they couldn't afford. When the housing market collapsed, they were rewarded with government-subsidized mortgage modifications and, in some cases, partial forgiveness on their loan balances. And now, under Rogoff's 6 percent solution, debtors would see more of their burden lifted.

"And we, the savers, get screwed again.

"'Zimbabwe Solution'...

"And who says the Fed can orchestrate 6 percent inflation and not let it get out of hand? You know what would happen to those well-anchored inflation expectations: Ahoy, matey, it's out to sea with you.

"'Trying to manage a slight increase in the rate of inflation in a discretionary way is not practical,' says Marvin Goodfriend, professor of economics at Carnegie Mellon's Tepper School of Business in Pittsburgh.

"Mankiw didn't specify his preferred inflation rate in the Bloomberg story. He was too busy to give me an interview, directing me instead to his New York Times column from last month where he proposed the idea of negative interest rates: not negative real rates, adjusted for inflation; negative nominal rates.

"The idea is 'to make holding money less attractive' so people will spend it."

Needless to say, we can't wait to see what happens. The Chinese already seem to think that holding dollars is less attractive than it used to be. But Geithner and Bernanke assured Wen Jiabao that his money was safe. We wonder what he'll do when he realizes they played him for a fool.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Cash is Created When the Feds “Monetize the Debt” by Buying US Treasury Bonds
• Simple Solution for Creating Inflation
• The More Money in a Financial System the Less Each Unit is Worth
• AIG to Receive $85 Billion Loan from Fed
• The Chinese and the Fed Both Buying U.S. Treasury Bonds

"The US is not alone in facing a deficit crisis," reports the U.K.'s Telegraph. "Governments worldwide have to raise some $6 trillion in debt this year, with huge demands in Japan and Europe. Kyle Bass from the US fund Hayman Advisors said the markets were 'choking on debt'".

"There isn't enough capital in the world to buy the new sovereign issuance required to finance the giant fiscal deficits that countries are so intent on running. There is simply not enough money out there," he said. "If the US loses control of long rates, they will not be able to arrest asset price declines. If they print too much money, they will debase the dollar and cause stagflation."

We'd also suggest that financial asset price declines will be accompanied by real asset price increases. Currency debasement has a way of leading to higher prices. As Mark Gilbert reports in Bloomberg, currency debasement as a way of dealing with huge debt is now a global phenomenon.

"All currencies are being debased dramatically by their central banks at extraordinary speeds and so in relative terms it appears there is no currency problem," Lee Quaintance and Paul Brodsky of QB Asset Management said in a research note earlier this month. "In reality, however, paper money is highly vulnerable to a public catalyst that serves to acknowledge it is all merely vapour money."

We would argue that one "public catalyst" which acknowledges that paper money is "vapour money" is the price of tangible assets. And that brings us to the other world to which Australia belongs. True, the country is following in the debt and debtor footsteps of the U.S. and the U.K. with its fiscal policy. But the private sector and the resource economy belong to the world of long-term structural demand growth from China and India. That world is a much better place to be, especially for investors.

A research report from Goldman Sachs JBWere says the "worst is over" for raw materials demand. It says investors should increase exposure to major resource companies. "We are becoming increasingly confident that the period of weakest demand for raw materials is behind us," wrote Malcolm Southwood. "We have also seen the bottom of the price cycle for base metals, and particularly for copper, which remains the most supply-constrained, and therefore our preferred commodity for investment exposure."

After the giddy heights of 2008, we take these pronouncements about commodities demand with a block of salt. After all, a cynic might think that brokerages were talking up the demand recovery story in Asia because their in-house trading desks are short the U.S. dollar and long oil, copper, and gold. However, if were we choosing which long-term investment was most appealing for Australian investors, we'd choose the China "V-shaped recovery" story. It will be nice if it's true.

But the question remains whether or not the resurgence in demand is just resource stockpiling or something more. And if it's something more, can growth in China's economy be sustained even as Europe, Japan, and the U.S. stutter, splutter, and splatter their way through the rest of the year?

And just to complicate matters, let's not forget that U.S. house prices fell by 19% in the last year, according to the latest Case-Shiller data. There is also serious erosion in the performance of "prime" mortgages, a $3.5 trillion market. It's entirely possible-we think it's likely-that there is another $1.5 to $2 trillion in losses coming, related to U.S. residential housing. The banks are not in the clear yet, nor are investors who own mortgage backed bonds or CDOs.

And we haven't even mentioned the commercial mortgage market. Did you read that Suncorp took a third-quarter impairment charge of $136 million because of falling Australian commercial property values? "Suncorp said its impaired assets increased by $255 million to $1.24 billion during the three months to March 31 after the Australian banking sector continued to be impacted by the deteriorating economy and declining property values," reports Dow Jones newswires.

That is the Anglo-Saxon world if debt-financed property inflation that Australia has one foot in. On the other foot, Newcrest's Ian Smith says the global economy may have "turned the corner." Bloomberg reports that Smith told a conference that fundamental demand in emerging markets is solid.

Advantage, developing world.

It's hard to know what to believe, then, isn't it? It's obvious the world's financial system is still broken. Specifically, the fiscal imbalances in the world's largest economies are economically unsustainable. But the political consequences of falling house and stock prices are unthinkable.

When political necessity meets economy reality, reality yields, if only for a short while. The result is currency destroying policies of quantitative easing and debt monetisation. And what does that mean? The long-term bear market in sovereign bonds has begun and tangible assets are rising, even though there is huge uncertainty over the prospects for the global economy.

Perhaps the best we can hope for is a reluctant compromise. The world's economy is not strong. But in some of the broken places, it is getting stronger.

Call it investment insight from Ernest Hemingway. "The world breaks everyone and afterward many are strong in the broken places," Hemingway wrote in A Farewell to Arms. "But those that will not break it kills. It kills the very good and the very gentle and the very brave impartially. If you are none of these you can be sure it will kill you too but there will be no special hurry."

More on death, adaptation, and survival tomorrow.

Dan Denning
for The Daily Reckoning Australia

• U.S. Treasury Auctioning Off $81 Billion in New Debt
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• A Possible Holocaust in U.S. Bonds
• Fed Willing to Print Money to Buy More Bonds to Keep U.S. Interest Low
• U.S. Government Must Roll Over $3.4 Trillion in Debt Over Next Four Years

Countries make mistakes too. Reliably. One empire declines so another can rise. In modern history, one western country has replaced another, as the world's dominant power, about every century. Spain until the Armada sank, France until the battle of Waterloo, England until 1914, and then America until...?

The mistakes made by America are the same mistakes that empires always make. "Imperial overstretch," it is called. Spain reached for England...and drowned in the North Sea. France stretched to Moscow...and froze in the snow. England's elastic stretched all over the world - to colonial outposts in Singapore, Australia, and Rhodesia. But by the time she was challenged by the Huns in WWI, her economy had already been surpassed not only by Germany but by America too.

Now, it is the US that wears the purple. It has its fingers in every pie, its ships in every port, and its red ink running over everywhere. Even at the very peak of its authority - in the '90s - it was already relying on the savings of poor people in Asia in order to continue its big spending ways. And now, confronted with the challenge of a worldwide financial meltdown...the obvious consequence of too much spending and too much borrowing for too many years...what does it do? Does it cut back? Does it bring the troops home and the deficit down?

NO! It spends and borrows even more!

In other words, it makes a grand, fatal mistake. Now, an amount equal to its total receipts must be borrowed just to keep the federal government going. Even taking 100% of domestic savings only brings in less than half of the amount needed to finance its deficit. So, the rest - an amount equivalent to the entire US military budget - must be borrowed from kind strangers, business competitors and potential rivals for power.

Sooner or later, the foreigners will not be so easy with their money. Instead of buying US Treasury debt, they will sell it. Instead of supporting America's imperial ambitious, they will undermine them.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Any Money That You Don’t Earn is Stimulus
• Housing Mistakes Embarrass the Rich
• The Return of the Cattle Market
• The Senate Votes to Burden the Entire Nation with Wall Street’s Mistakes
• The Greatness of a Depression is Commensurate to the Government’s Efforts to Prevent It

Does it mean that American "consumers" (so-called) are awaited momentarily in the flat-screen TV sales parlors with their credit cards fanned-out like poker hands, ready for "action?" Not too likely with massive non-performance out in cardholder-land, and half the nation's electronics inventory wending its way onto Craig's List. Are we expecting more asteroid belts of new suburbs carved in the loamy outlands of Dallas and Minneapolis, complete with new highway strips of Big Box shopping and Chuck E. Cheeses? Go to banking's intensive care unit and inquire (if you can) among the flat-lining production home- builders and the real estate investment trusts on life support when they expect to rev up the heavy equipment.

The idea that we're about to resume the insane behavior that induced the current epochal malaise of economy is so absurd it will only be heard in the faculty dining halls of the Ivy League. And if America is not picking up where it left off eighteen months ago - the orgy of spending future claims on wealth unlikely to accrue - then what is our destiny? Based on what's out there in the organs of public thinking, it seems that we don't want to think about it.

So many forces are arrayed against a return to the previous "normal" that we will be lucky, in another eighteen months, to still find ourselves speaking English and celebrating Christmas. What's "out there" is a panorama of mutually reinforcing critical problems pertaining to how we live on this continent. Like the obesity, heart disease, and diabetes that plague the public, these problems are disorders of lifestyle habits and the only possible "cure" is a comprehensive revision of lifestyle. With the onset of spring weather and the cheez doodles and monster truck rallies and NASCAR tailgate barbeques and the drive-in beer emporiums all beckoning, can the public shift its attention from these infantile preoccupations to saving its own ass?

So far, the most striking piece of the economic fiasco is the absence of any galvanizing spirit among the millions getting crushed in the tragic unwind of our relations with money. It will be interesting to see, for instance, if there is any uproar over the evolving story of Goldman Sachs' latest raid on the U.S. Treasury, after booking billions in taxpayer-funded payouts funneled through AIG, based on double-hedged credit default swaps. Such magic tricks are understandably hard to follow, but a dozen-or-so federal attorneys with a middling background in differential calculus might suss out the trail that leads from Ben Bernanke's work station to Lloyd Blankfein's cappuccino machine. Something similar may be said in regard to revelations last week of White House economic advisor Larry Summers' connection with a number of hedge funds shoveling millions into his deep pockets for showing up once a week to cheerlead their "innovations" - not to mention his shadowy visits to the Goldman Sachs gravy train even after he signed onto the Obama campaign. As long as the stock markets seem to rally - no matter what else is really going on in America - nobody will pay much attention to these disgusting irregularities.

Since it is that time of year, and I am haunting the gardening shop, one can't fail to notice the many styles of pitchforks for sale. My guess is that the current mood of public paralysis will dissolve in a blur of blood and spittle sometime between Memorial Day and July Fourth, even with NASCAR in full swing, and the mushrooming ranks of the unemployed lost in raptures of engine noise and fried cornmeal. It doesn't take too many determined, pissed-off people to create a lot of mischief in a complex society.

On the agenda in the second quarter of '09 are ominous rumblings in the oil and food sectors. Half a year of cratered oil prices have decimated the oil industry and we're driving at 100-miles-an-hour straight off a cliff into a new kind of supply crisis - even if industrial production and global exports remain moribund. So many drilling rigs are being decommissioned that the oil industry itself looks like it's preparing for its own death, investment in exploration and discovery has withered with the credit markets, and the world may never recover from the year long hiccup in oil industry activity - translation: peak oil is biting back now with a vengeance. Its peakness will look peakier and the yawning arc of depletion beyond will look steeper and pose a threat to every globalized and continental-scale enterprise in the known world.

So many dire elements are ranging around our food production system (i.e. farming), from widespread drought and water table depletion to "input" shortages (especially fertilizers) to sickness in credit availability, that we're all one bad harvest away from something that will make Pieter Bruegel-the-elder's "Triumph of Death" look like Vanity Fair's annual Oscar Party in comparison.

Barack Obama, charming as he is, had better drop his pretensions about kick-starting the old consumer economy, fire the Wall Street clowns and parasites who are running that futile exercise, and start preparing a US Lifeboat Economy aimed at reducing the scale and scope of our outlays so we can survive the coming siege of austerity. Meanwhile, I'm glad that he finally got a dog for the White House, because the President knows full well where to turn in Washington if you want some genuine love and affection.

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

• Rising in Defense of Goldman Sachs
• Higher Oil Prices, the New Normal
• Meredith Whitney and the Buy Recommendation on Goldman Sachs
• Economy Free to Recover?
• It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position

We all agree that this is truly breathtaking stuff, and the "knockout blow" is that "the Fed will officially begin buying 'longer-term' U.S. Treasury notes. The FOMC said they'd spend at least $300 billion over the next 6 months" which is known as "sterilization" and I say is a lowlife stinking fraud where the Federal Reserve creates money out of thin air, then uses the money to buy Treasury bonds, agency debt and/or (literally) buying anything that they want, as much as they want, anytime they want, which they are doing because the Federal Reserve has destroyed the economy by creating so damned much excessive money and credit that nobody in their right mind is going to buy any stinking Treasury bonds yielding (in the original Spanish) el squato when inflation will be raging higher than the puny yield, meaning that bond prices will collapse and interest rates will rise, which is the last thing that the Fed or the government wants.

As the comedian Dana Carvey's Church Lady character used to say, "Now isn't that special!"

Of course, there are people in the world who are not as stupid as us Americans, and they look at this and say to themselves, "Holy crap! The American central bank, with what appears to be cowardly compliance from their federal government, has committed the ultimate economic sin, and we had better get our money out of that stupid currency before it loses all of its purchasing power!" which resulted in a fall in the dollar on the forex market, or, as The 5 puts it, a "2.7% drop for the dollar index - its worst one-day performance since 1971 when the index began."

Neil Irwin at the Washington Post reported, with that subtle-yet- unmistakable hint of panic, "The Federal Reserve yesterday escalated its massive campaign to stabilize the economy, saying it would flood the financial system with an additional $1.2 trillion."

Aghast, I raise a shaky index finger to direct your attention to Mr. Irwin's appropriate use of the adjectives "massive", "flood" and "additional" to describe the sudden scary appearance of "$1.2 trillion" in promised expansion of the money supply by the Federal Reserve, which is so scary that this is where Mr. Irwin lost valuable Mogambo Stylistic Points (MSP) when he forgot to extend "$1.2 trillion" into a phrase that would reflect the preceding phrases.

So, according to the Mogambo Big Book Of Economic Editorial Style (MBBOES), It should have read (in light of preceding adjectives "massive", "flood" and "additional"), "$1.2 trillion, which is a freaking unbelievable orgy of monumentally irresponsible monetary and fiscal insanity that not only makes you pee in your pants in terror of the inflation in consumer prices that will inevitably follow such enormous expansion of the money supply, but is even more terrifyingly that this same deficit-spending lunacy is forecasted far, far into the future, too, making the total situation of such a horrific magnitude that you can be fully justified in screaming your brains out in horror and outrage, being, as you are, 100 percent sure that it will destroy us completely by the simple expedient of destroying the purchasing power of existing dollars by creating too many new dollars!"

Bill Bonner here at The Daily Reckoning notes, "In response to the Fed's latest move, the yield on 10-year Treasuries fell more than any time since they started keeping records in 1962. From 3.01% it had fallen to 2.48% when last we looked" which seems paradoxical, since normal people would look at this massive creation of money and know that it means higher consumer prices, which means that bond yields would rise! And yet bond investors bought bonds, driving their yield down! Weird!

But this is the kind of stupidity that makes investing in gold, silver and oil so easy and cheap! Whee!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• Federal Reserve to Buy $300 Billion In U.S. Treasury Bonds
• Federal Government Making Taxpayers Pay Taxes for Nothing
• Federal Reserve Boosted Total Fed Credit
• The Destruction of the Dollar by the Federal Reserve
• Wounded Wolves on the Financial Prairie

--Here in Australia, bad news rolls on in the labor market. Pacific Brands is sacking 1,850 jobs in Australia in a bid to boost its fortunes. Profits got to shareholders, and shareholders are Australians who also wear underwear. Thus a dilemma, what if what's good for Australian shareholder s in general is bad for the 1,850 workers of Pacific Brands who won't be making jocks any longer? Which group should be favoured?

--Discuss. Our answer tomorrow. Hint: even if we all went out and bought a pair of bright pink Bonds today, it wouldn't solve the company's problem.

--The share market is digesting the ambitious speech Barrack Obama gave to the U.S. Congress. He's going to cut the U.S deficit in half, increase spending, provide universal health care, improve education, replace oil with alternative energy, introduce a carbon cap and trading scheme...and that's just before lunch!

--You have to wonder what kind of Kool Aid the folks in Washington are drinking. Do they not realize that the nation which they claim to represent is actually going bankrupt? The U.S. government has already made too many promises it can't keep. Making more isn't going to improve things.

--But in a democracy, the people demand action and handouts and a plan! So give it to them good and hard, as H.L. Mencken would say. They're going to get a plan alright. And it's going to involve borrowing lots of money.

--It's no wonder the stock market is depressed. You half expect Mr. Market to take sickie and spend the day at the pokies. Or drinking gin.

--It's optimistic, but there's a chance the status quo could be maintained for about six months. You'd have a directionless market, a range-bound gold price (between US$900-$1,000) and a steady drip of negative economic news. Why six months?

--That brings us to the Capital Assistance Plan (CAP) announced yesterday by the U.S. Treasury. The CAP is designed to solve the problems in the U.S. banking sector. It aims to do this by given the appearance of thorough audit of bank assets and capital requirements (under different scenarios) and then giving the banks six months to raise additional required capital in the private markets, or, to sell convertible preferred shares to the government at a yield of 9%.

--The first part of the plan makes plenty of sense. Behind closed doors, regulators want to meet with the banks and take a good hard look at the books-ALL the books-and see if the banks have adequate capital to survive if the economy contracts by another five percent this year.

--In its white paper on the program, Treasury states that, "In their assessments, regulators will incorporate off- balance-sheet commitments, earnings projections, risks of the banks' business activities and the composition and quality of their capital." Once that's done, the banks, the Treasury, and most importantly, private investors should have a reasonable idea of how much capital the banks need.

--You can see what the Treasury is trying to do. And it's headed in the right direction. Treasury believes that if the banks can provide the marketplace with an audited and accurate statement of their risk going forward, cashed-up private investors might be more than willing to provide capital. Transparency leads to freer flowing investment.

--That's what they must be hoping anyway. One problem we can think of right away is that there are two scenarios used to determine capital requirements and adequacy, a "baseline" scenario and a "more adverse" scenario. The "baseline" scenario reckons on a 2% contraction in U.S. GDP this year and 2.1% growth next year. The "more adverse" scenario reckons on a 3.3% contraction this year and a 0.5% expansion in 2010.

--Does this make sense, though? GDP could expand this year by virtue of the government stimulus package. You'd have the illusion of more economic activity without any actual improvement in the quality of banks assets (which remains the core issue).

--Besides, maybe Treasury should include a "really adverse" scenario in which GDP contracts by 5-10% this year. After all, all over Asia GDP is falling like a stone as exports decline and industrial production cliff dives. America is not going to export its way out of a slump when its trading partners are faring even worse.

--And another thing. U.S. existing home sales were down 5.3% in January. Median prices are down 14.8% year over year to a suddenly intriguing US$170,300. Now, if people could just get a loan! Seriously. Prices are reaching that "clearing" level where you might see an uptick in demand.

--But the Treasury plan probably does not include a contingency where house price fall another 10%. If that's the case, the banks will need more capital than you can imagine. And remember, it's not going to come from savings. It's going to come from money the Treasury gets by borrowing, raising taxes, or from the Fed.

--Inflation. Get ready for it. Now or in six months. It's the only real way to grow GDP, although it will be bogus growth. Six months. IN the meantime, maybe the market will buy this plan. Or maybe it will be left in a state of uncertainty. That gives you time to execute your own plan. More on that tomorrow.

--Finally, our apologies to the alligator fruit! We had no idea...really...very sorry. Eat more!

--Dear Folks,

Offering a fellow who's dying of coronary artery disease a cheeseburger with bacon certainly wouldn't help, but you got it WRONG about the AVOCADO!

There are "good fats" and "bad fats". The bad fats clog your arteries and cause clots to form, resulting in heart attacks, strokes, and other nasty things. The good fats prevent these things.

Saturated fats such as are found in beef fat and cheese are bad fats. Trans fats, such as are found in lard and the oil used for deep frying French fries are even worse - as they cause inflammation of the clogged arteries - clots tend to form on areas of inflammation. It's the clot which completely blocks blood flow in the artery - which does you in - not the hardening of the artery.

Medium chain triglycerides are good fats - they do not harden arteries and decrease arterial inflammation. They are found in plants - mostly in seeds. Examples of medium chain triglycerides are - ta da! - avocados, most nuts, sunflower seeds, canola (formerly called rapeseed but that was deemed politically incorrect - I couldn't make this up!) oil, olive oil and flaxseed oil.

So there you are - go forth and eat your avocados!

Best -

John D. Foster, M.D.
Atlantic Beach, Florida
U.S.A.

Dan Denning
for The Daily Reckoning Australia

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It had been hoped that the Geitner plan would support a further rally in the stock market. In fact, he only spoke for half an hour. During that period the S & P 500 fell by 3.4 per cent. The market – and particularly the traders – was disappointed by his lack of detail. Some people expressed disappointment that he did not commit the new administration to drawing a line under the crisis. The new administration had allowed expectation of a New Deal to grow, and this was not a new deal.

On Wednesday, the Bank of England published their inflation report, which was preceded by a briefing by the Governor of the Bank, Mervyn King. Mervyn King had a better response than Tim Geitner, though he would be embarrassed for anyone to say so. The Bank of England did not draw a line under the recession, but it did reveal a new forecast. It expects the trough of the recession to come in the middle of 2009, to be followed by a recovery which would take the British economy back into growth by the Spring of 2010. This is the V shaped recovery which everyone, not only in London, is hoping to see. As it is unlikely that the British economy will have so strong a recovery in the year from mid-2009 to mid-2010 unless there is a strong global recovery, we can take the V shaped recovery as the Bank’s forecast of the major world trend.

The Governor qualified this relatively optimistic forecast by discussing the “paradox of thrift”. “In the longer term,” he said, “the national savings rate will have to go up. In the short term, if it were to rise now, we’d be in an even deeper recession.” The recession happened because of the mishandling of debt, both in Britain and in the United States. Yet, on this argument it is necessary to create an environment of higher spending, lower saving and rising debt, if the world is not to be sucked downwards in a deflationary spiral. We have to do all the wrong things in order to achieve short term recovery. This is against a Central Banker’s instinct. Indeed it puts the short term ahead of sound longer term finance.

The Bank of England is preparing to embark on “quantitative easing”, in order to turn round the recession in the period 2009-2010. This scares everyone. Neither the United States nor the Eurozone has embarked on quantitative easing – nor indeed has Britain, as yet. The Governor’s actual words were: “When it comes to being able to do a wider set of operations involving the Monetary Policy Committee, I’d like to think that when the M.P.C. meets, it will be in a position do to that.” The Monetary Policy Committee will next meet on March 5th, so Britain may be only three weeks away from an experiment of a computer generated money supply increase. The money will not need to have been printed, but there will be an addition to the U.K. money supply. Flat money will have become virtual money, or perhaps one should say that virtual money will have become flat money. This scares me, and I think it scares most people.

The best hope is that the recovery in the 2009-2010 period will actually occur. The model for the Recession of 2008-2009 has so far been the Great Depression. The Great Depression started with the Wall Street panic of October 1929. The low point came in the middle of 1933 if one measures in terms of growth of G.D.P. The present Recession started in August 2007, with the first freeze of interbank lending. From start to trough in the Great Depression was about eleven quarters. If the present Recession lasts for eleven quarters from the beginning to the trough, then the trough will come in the first half of 2010.

That would be nine months later than the Bank of England forecast, and it would suggest that a return to growth would come in 2010-2011 rather than 2009-2010. But perhaps many of us would now settle for that.

William Rees-Mogg
for The Daily Reckoning Australia

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Ten-year U.S. Treasury bond yields are coming down as investors lose confidence in Tim Geithner's plan. Yes, it's really weird that the U.S. government can successfully auction US$21 billion in ten-year notes at the same time it plans on growing its annual deficit by $1.5 to $2.5 trillion. But it's a weird world we live in. Foreign central banks snapped up 38% of the auction, according to Reuters. This is like buying a lead life vest as your ship goes under the waves.

The Treasury is hawking $187 billion worth of U.S. debt this week. That's ambitious. Most of it, though, is shorter-maturity notes and bills. Only $14 billion in 30-year bonds will be auctioned. Meanwhile, $32 billion in three-year notes is up for grabs to the highest bidder.

The good news for Team America is that Treasuries are joining gold as a safe haven asset. Investors are growing more convinced that the banks are simply lying about future losses they know they'll have to take. The banks don't want to sell impaired assets at a loss. It would force them to ask for more government capital with strings. Or, it would make them insolvent.

So Treasuries go up. But the bad news is that yields are creeping up too. The three-month yield is at 1.41%, the highest it's been since November. It's an extremely boring subject, but if you look at the composition of America's publicly traded debt, more and more of it has shifted to the short-end of the interest rate curve, 2-year, 5-year notes and 10-year notes. If you get a sudden spike in interest rates, the cost of these monthly auctions--and there are going to be a lot of them this year and next--goes dramatically up for Uncle Same.

Dig deep you taxpayer you!

What would cause a sudden spike in interest rates? It's not what. It's who. The bond vigilantes!

This is the media name for the bond traders who scuppered Bill Clinton's big spending plans during his first term. Back then, the market was capable of imposing some fiscal discipline on the U.S. government by forcing it to pay higher rates of interest for the debt it sold to finance its spending plans.

Today, those spending plans are much larger. The government is not behaving in a fiscally disciplined way. But the bond vigilantes are at war with the equity nervous nellies. That is, the shock and dread of higher inflation that would normally accompany such big spending plans and send rates higher is at odds with the paralyzing fear that owning stocks is an even bigger risk than owning U.S. Treasury bonds and notes.

Maybe this was Geithner's plan all along. Drag his feet on the bank plan to maintain the foreign bid on U.S. debt. Sell the debt to finance the stimulus, then screw the bondholders later when you have to monetise the debt to finance the aggregator bank. Hey, it's not so unlikely is it?

Reuters reports that, "The Bank of England will probably have to ease monetary policy further to get the economy growing again, and could start buying gilts as soon as next month to achieve that, Governor Mervyn King said on Wednesday." Quantitative easing is pure money printing. The central bank prints money to buy government debt. Someone has to buy that debt, you know. And if no one in the marketplace is going to do it, in steps the central bank.

This is a recapitulation of the strategy in Japan that failed. It's a preview of what the U.S. will probably do as well. The government is pouring trillions into the sinkhole of a decade's worth of bad investment in residential housing. All that money--which is capital not going to the private sector to build tomorrow's factories which would create tomorrow's jobs and incomes--is borrowed from the future. The interest on it will have to be paid with higher taxes.

What has the government done to our money? More on that tomorrow.

We have to call it quits on the DR for today so we can wrap up the February issue of Diggers and Drillers. The flip side of the snowballing U.S. public debt is, of course, the rise in precious metals and inflation hedges. If there is a "golden parachute" the inflationary crisis, it's going to be in the metals that have historically been money. As the bullion angle is well covered elsewhere, we've taken a look at platinum this month, as well as the Aussie gold miners and which ones are most likely to follow bullion up, should it keep going up.

One last note. Brokers and talking heads are talking up gold. That's worrisome in the short-term. It means you could see a big spike up in gold back to $1,000. And then? Profit taking. That doesn't change our long-term outlook at all. Just keep in mind that any time you get this much momentum, it's bound to exhaust itself. You'll get a shakeout, a consolidation, and, if we're right, a resumption of the move higher.

Until tomorrow!

Dan Denning
for The Daily Reckoning Australia

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