It takes water to produce energy and energy to produce clean water. That nexus creates a number of profit possibilities. Sometimes, they are not so obvious. But often, a company that possesses expertise in water treatment will possess a related expertise in the energy field. The connection between water and energy is at least as old as the process of pumping water into old oil fields to boost production.

But the connection between these two precious fluids is changing quite a bit.

Let's take a look at one of the less-obvious connections...

You may not realize this, but two-thirds of oil discovered stays in the ground. The average recovery rate is only about 35%. What if we could recover more of the oil we've already discovered?

If the recovery rate improved to 50%, the world's recoverable oil would increase by 1.2 trillion barrels. It would double today's proven reserves, says the IEA. That much oil makes even a cynical old oilman catch a gleam in his eye and starts his heart aflutter. Indeed, lots of big brains churn away at this problem day and night.

"It's the prize for the next half century," says Howard Mayson, vice president for technology at British oil giant BP, quoted in this morning's Wall Street Journal. BP relies heavily on enhanced-recovery methods. These methods aim to improve that oil recovery rate.

As The Wall Street Journal reports:

"Enhanced recovery is a lifeline for the biggest oil companies, such as Exxon Mobil Corp. and BP, which are under intense pressure from shareholders to keep ramping up production and gaining access to fresh reserves. But that's hard to do when the companies are shut out of the oil-rich Middle East and places like Russia. So they rely more and more on existing fields, some of which have been producing oil already for decades."

It is like squeezing a sponge ever tighter to extract the most of what you can get. The old method is to simply flood the reservoir with water. The idea is to create enough pressure to make it easier to pump the oil out. It is not very efficient, but it works for a time. It is also becoming a bigger problem to secure the water supply. That's why we see oil companies buying water rights out West. Currently, the shale oil plays consume a lot of water.

Instead of using water, some companies will pump the reservoir with carbon dioxide. Companies used to store carbon dioxide in old unused reservoirs. Using this method of enhanced oil recovery, they put that carbon dioxide to work. BP uses this method out in its Prudhoe Bay reservoir, to great effect. Recovery rates there are 60%. Now Prudhoe Bay, which people in the 1980s once thought would cease pumping oil in 30 years, looks to be good for another 50 years.

The WSJ describes another method BP uses: "flooding reservoirs with polymers that expand like popcorn when they come into contact with hot rocks, thus flushing more oil out of difficult-to-reach nooks."

The name of that polymer is BrightWater. One company has a patent on this material and makes it for a profit. That company is Nalco Holding (NLC:NYSE), a company I recommended several months ago to the subscribers of Capital & Crisis. BP uses BrightWater in Argentina and Pakistan. "BP says the additional oil the new technology will produce over the next 20 years is roughly equivalent to finding a major new field," reports the WSJ.

"Nalco," you say, "but isn't Nalco is one of the world's largest water purification companies for industrial companies?" This is what we mean by energy-water nexus. The two are related. And Nalco sits right in the middle of that nexus.

Last year, Nalco's energy services segment was a bright spot. Sales grew 17% organically for the year. In the fourth quarter, sales were up 23% despite the steep oil price decline. In that segment is Nalco's enhanced oil recovery (EOR) business.

CEO Erik Fyrwald commented on this business in a quarterly conference call. "We are in with a lot of oil companies explaining and talking to them about it," he says. "We believe as oil prices come back up, [EOR will be a] really big growth opportunity, just delayed for a period of time."

The delay stems from the fact that many oil companies slashed their exploration and production budgets last year, when oil and gas prices were falling. But it seems inevitable that as the big oil reservoirs dwindle, the EOR business will be big down the road. Of course, EOR is only one of the many valuable things Nalco does in the energy-water nexus. It is no wonder why Warren Buffett's Berkshire Hathaway is the biggest shareholder.

Nalco is a long-term buy.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• Water Usage by Big Companies
• Unsustainable Energy Trends
• Price of Water Rises in China
• Buying Oil on Sale as U.S. Dollar Gets Weaker
• Top Resource Prices in 2008: Food, Water, Energy & Metal

- Edward Gibbon

Warren Buffett famously says that people do not make money by betting against the US economy. But two years ago we decided to take a chance.

"We are short the United States of America," we announced from the comfort and safety of our headquarters in London. "Sell its stocks. Sell its bonds. Sell its money. Sell its real estate. Sell the equity. Sell the debt. Sell everything."

What we saw was an over-stretched empire getting ready to snap. But we were also allowing ourselves to be lazy. Rather than deconstruct the capital structure of the world's largest economy, we decided to sell the whole damned thing.

All Hell broke loose in September 2008. Since then, US stocks have gone down about a third. Real estate too. Unemployment has doubled. Consumer prices are going down at the fastest rate since the '50s. And the economy is in the worse recession since WWII.

Meanwhile, Americans' per capita wealth has fallen from $172,000 in September from $212,000 two years earlier. And the UN reports that the quality of life in America has gone down too...from #5 on its list in 2000, it fell to #13 in 2007. No doubt it is below #20 now.

Buffett has lost billions betting on the US economy while our gold positions are handily up; gold was the most profitable major asset over the last ten years.

So you see, we were right; America was a sell two years ago.

And now it is the dollar that is falling. It's gone down 12% in the last six months - a huge move for a major currency.

"Asia tries to slow dollar fall," is the lead story in today's Financial Times.

Today, a buck and forty-seven cents will buy you only 1 euro. Ten years ago, you could have gotten a euro for less than a single dollar. A falling dollar makes imports more expensive, say analysts...raising the cost of living in the homeland. But you wouldn't know it from walking around on the streets of Miami or Las Vegas. You can get a house at 50% off its price three years ago. As for the breakfast special - for less than 3 euros you can get enough food to kill a Pakistani.

By European standards, America is cheap.

"Europeans again interested in Florida houses," says a headline in The New York Times.

House prices are down 30% to 50%. The dollar is down about a third too. That makes the United States a bargain.

But is the United States of America about to become even cheaper?

One thing we were wrong about when we issued our 'sell America' call two years ago was US debt. Treasury bonds have resisted the general downward trend of things with the stars and stripes on them. Bonds have not gone down; they've gone up.

Private households are buying them for their retirements. Banks are buying them for risk-free profits. Speculators are buying them in anticipation of deflation.

David Rosenberg:

"The big story yesterday was the further massive $12 billion decline in outstanding consumer debt in August - the consensus was looking for an $8 billion contraction. This was the seventh month of debt retrenchment in a row. In other words, the tidal wave of the credit collapse continues unabated, and this is the primary reason why bond yields are still in a fundamental downtrend.

"Over the past year, consumers have run down their debt by a record $113 billion (and this does not include mortgages). This is an absolutely epic shift in household attitudes towards credit and discretionary spending."

Americans are saving. And they're buying US Treasury bonds. (More below...) But how safe is their money? Is it a good idea to buy US debt now?

On Wednesday, Latvia tried to raise a trivial amount of money. It offered $17 million worth of 6-month bonds. How likely is it that Latvia will default before Easter? We don't know, but investors judged it not worth the risk. Not only did the bond auction failed, it failed with no bids.

That's what happens when lenders lose faith in a government. They refuse to lend it money - except at high rates of interest. But the high rates of interest work like a noose on the neck of a cattle rustler. They block the vital flow of oxygen - not to mention breaking his neck.

Note that the US federal government is still functioning like an empire at the peak of its power. The Pentagon is still rustling up trouble all over the world - at a cost of trillions. US government employees are growing more numerous and richer - with twice the annual incomes of the private sector. And the Obama Administration - apparently unaware that the total unfunded debts and obligations of the federal government have soared to nearly $120 trillion - is considering new ways to get rid of cash.

Remarkably, investors still lend the US government money - asking only 4% annual yield on a 30-year loan. As for 91-day money, they practically give that to the feds for free; it sports only a yield of 0.066%.

This will surely be a point of puzzlement for the financial historian of the next century. It is certainly a point of puzzlement for us.

Yesterday, gold hit a new record at $1057. Doesn't gold go up when inflation rates rise? And don't bonds go down when inflation goes up?

So why are people buying bonds with such puny yields?

There is a lot of whispering in this market. Gold is trying to tell us something. Bonds are trying to tell us something. The dollar seems to have something on its mind too. Stocks are just babbling.

If gold is trying to signal that inflation is coming, the bond market is not paying attention. Bonds seem to be saying that it is deflation we should be worried about; but the stock market doesn't seem to hear.

And there's the dollar. The greenback is in the same choir with stocks and gold, as near as we can tell. They all seem to be chanting about inflation coming back.

But what if they're all wrong?

Just look at what is going on in Washington, if you can bear it.

The feds have a budget that anticipates inflation and growth. Spending is supposed to remain flat until 2013. Tax receipts, which are no higher today than they were 10 years ago, are supposed to rise, gradually filling in the Grand Canyon of deficits. The number crunchers think we're headed back to the Reagan years - when the tough-love policies of the Volcker Fed squeezed out inflation and created a real boom. Then, tax revenues rose 9% per year between 1984 and 1989.

How likely is that today? Not very. Instead, what is likely to unfold is a deflation story. Instead of staying flat, federal expenses are likely to rise as one failed stimulus gives way to another failed stimulus. Then, instead of going up, tax revenues will go down...digging an even grander canyon between out-go and income.

Then, or long before, there will be a panic out of bonds, the dollar, stocks - practically everything. Everything goes down!

At this point, the US will be in about the same situation as the Roman Empire as it approached retirement. Expenses kept rising. Rome had to pay the Blackwater-type military contractors of the era...in addition to keeping Roman mobs supplied with food stamps and unemployment benefits...while its tax base fell. Gradually, the empire lost the ability to defend itself.

When Edward Gibbon began his history of Rome's decline and fall, Roman real estate had probably been in a bear market for at least 1300 years. Rome's population fell from over a million to under 20,000. Politically, Italy had broken apart more than 1,000 years before Gibbon was born, and it wouldn't be put back together again until nearly 100 years after he was dead.

It's far too early to write the story of America's decline and fall. That job will fall to some future historian, perhaps seated on the ruins of the Lincoln Memorial, wondering how people made such a mess of things.

Our guess is that he will come to the same conclusion we have: Stocks? Bonds? The dollar? Investors should have sold them all!

Bill Bonner
for The Daily Reckoning Australia

• America’s Decline as a Great Empire
• Warren Buffett Says American Economy is a Shambles
• Mistakes Made By America Are the Same Mistakes That Empires Make
• Deleveraging Will Give Us a Bout of ’30s-Style Deflation
• Biggest Problem With US Economy is Too Much Debt

The story goes, Achilles was dipped in the river Styx and made invulnerable. But his mother held him by his heel, leaving that part untouched by the magic waters. Naturally, that is where a poison arrow got him.

The moral of this story is that you have to go all the way. If you want your baby to be invulnerable, put him all the way under the water...even the heels. Or, maybe there's another point: that there's always some place where you're vulnerable.

For the purpose of today's tale, we'll take the second possibility. Try as you may, you can never escape all risks.

All over the world, consumer prices are falling. The world has too much capacity...too many factories...and too many workers. Too many, that is, for current demand. The 'world's mouth' - the USA - has gone on a diet. And if the United States reduces its intake, that means the rest of the world - especially China - must reduce its output. Otherwise, the whole thing will become unbalanced.

Yesterday's news tells us that despite press reports of a recovery, the key indicators of real economic growth are still falling. Almost one out of ten mortgages are now delinquent. And the rate of foreclosures is increasing faster than any time in the last 30 years. Housing prices, meanwhile, fell 16% in the 2nd quarter, from a year earlier, according to the National Association of Realtors.

Unemployment claims went up last week. The sharp eyes of The Financial Times see the link: "Mounting joblessness fuels US housing crisis," says its headline.

In the real economy, people are cutting back...with the inevitable results we discuss every day here in The Daily Reckoning. One major consequence of reduced demand is too much supply. The factories built in China to supply products to America during the bubble years now find they have no market.

Currently, overcapacity and oversupply are causing prices to fall. Falling prices mean rising currency values. Each unit of 'money' buys more stuff. But there are many competing currencies, and they don't all rise and fall together. Even in a world of deflation, some currencies will deflate more than others.

The dollar is, of course, the world's main money. In a sense, the whole world economy is under its heel. But it is a heel that has never been dipped in the river Styx. It is now a heel that waits for an arrow.

PIMCO is the biggest manager of bond funds in the world. It says the greenback is going to lose its status and lose its value.

"Investors should consider whether it makes sense to take advantage of any periods of US dollar strength to diversify their currency exposure," says its Emerging Markets Watch report. "The massive amounts of US dollar liquidity produced in response to the crisis" doom the currency.

Both China and Russia are calling for a new global currency to replace the dollar.

"While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the US dollar as a store of value even in the absence of a single viable alternative," continues the PIMCO report.

Meanwhile, our old friend Jim Rogers says he is moving all his assets out of dollars and buying Chinese yuan. And Warren Buffett warned this week - writing in The New York Times - that "greenback emissions" threaten the whole world econo-system.

But what does it mean? What are the threats to you? What are the opportunities? If you pay your bills and keep score in dollars, what does it matter if the dollar loses value against the yuan? If prices are generally falling, the dollar is actually getting stronger, isn't it? So what if some other currencies are getting even stronger still?

Colleague Bill Jenkins, at Master FX Options Trader puts in his two cents:

"We lived through a financial earthquake in 2008. The effects of it are still being felt. Aftershocks may still be ahead. But predicting when they'll strike is just as hard as predicting natural earthquakes. We had a number of prognosticators for years telling us about what would happen last year; it's just that they didn't know when. And that is the hard part of the life of a prophet.

"And while it is equally difficult to tell when the next economic tremors will hit, we can look at the numbers and make some predictions as to their cataclysmic effect."

Bill goes on to say that he thinks the US is headed for another shockwave...which will include another round of dollar buying - even while the 'experts' are touting 'green shoots' and a return to normalization.

The trouble with the Achilles' heel is that it is connected to the Achilles' tendon...which is connected to the leg muscles...which is what keeps the whole thing moving forward. Cut the tendons and the feet go flippety, floppety and you get nowhere.

Yesterday came word that the US deficit for 2009 might come in lower than expected. Instead of borrowing $1.8 trillion as anticipated, the feds might only borrow $1.58 trillion. Well, that still leaves them about $680 billion short - even if every dollar of trade deficit and every dollar of domestic savings is applied to it. But definitely a step in the right direction! This gap must be closed by quantitative easing, or, in other words, by printing press money. So, holders of old dollars are bound to wonder how much their savings will be weakened by the addition of so many new ones.

They're likely to wonder, too, how much those US Treasury notes will be worth after this monetary inflation catches up to them. At some point, they are likely to think twice about buying more of them...and possibly even want to sell the ones they have already. Either way, it could create a nasty financial whirlpool that sucks down the entire world economy. As private investors reject US dollar credits, the Fed would be forced to print up more money to buy them itself. As the Fed buys more, private investors become more fearful that this monetary inflation will lead to consumer price inflation; they may panic and dump all dollar-denominated assets.

But if investors drop the dollar, what do they take up in its place? Oil...maybe. Oil is selling for $72 a barrel, even while the world is in a major downturn. What makes it so expensive, if not the fear that the currency in which it is quoted is more slippery than the black goo itself?

And gold? Yesterday, gold lost $3. But is still trading in the mid- $900s - not far from its all-time high. And this at a time when consumer price inflation is going down! In the US non-oil export prices are falling at a 5% rate. If people are buying gold as a hedge against inflation, they must know something we don't. Consumer prices are falling...actual CPI rates are negative in many countries already. Take out the effect of speculation on oil and commodities, and deflation is probably a fact of life almost everywhere. Gold buyers are not hedging against an increase in the price of bread, in other words; they're hedging against a poison arrow directed at the dollar itself.

Though gold may not make you rich tomorrow, as a long-term investment, there's nothing better. Strike while the iron is hot...or, while gold is relatively cheap. It's sure to get much higher than it is now...perhaps as high as $2000 an ounce.

Bill Bonner
for The Daily Reckoning Australia

• A Dollar Crash Will Have Disastrous Implications for Global Financial Markets
• Will Synchronized Rate Cuts Solve International Financial System Problems?
• 4 Ways to Protect Against a Falling Dollar
• The More Money in a Financial System the Less Each Unit is Worth
• Prices of Gold in the Top 10 World Currencies

Here is Warren Buffett's view:

"Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need.

"They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue.

"The United States economy is now out of the emergency room and appears to be on a slow path to recovery."

This is probably the view shared by most economists and most investors. It is not our view. From where we sit there is no recovery underway...and there never will be one. You can recover from a hangover. You can recover from a nasty divorce. You can even recover from an earthquake. But once a depression begins, you can only endure it. Get on with it. Get it over. And then, you can begin rebuilding again. You will never recover the economy you had before the crisis. You must find a new economic model.

A headline from yesterday: "Reluctant shoppers hold back recovery."

That's one way to put it. Shoppers don't have any money. They need to cut back. Most likely, they will cut back until their savings rates reach 10% of disposable income. That will take $1 trillion out of consumer spending. The economy cannot possibly recover under those conditions; it can't return to its same old, consumer-led, credit-fuel self. Instead, it must go through a period of transition - in which output is depressed - until it finds a new personality, better suited to the new economic circumstances.

But Buffett is not worried about the depression. He's worried about how the recovery is financed:

"...enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself."

Buffett does the math. This year, the US deficit will total $1.8 trillion. Since 1920, the largest peacetime deficit was 6% of GDP. This is 13% of GDP. The magnitude of it alone should be cause for alarm. But there's more. Where does this money come from? Even if you could direct 100% of the net US trade deficit (about $400 billion, the money that ends up in foreigners' hands as a result of American spending) and 100% of American's savings (estimated to be about $500 billion), you'd still be $900 billion short.

Desperate borrowers should expect to pay high rates of interest. A borrower who doesn't need the money can shop for the best rates and hold out for a good deal. But when a person needs to borrow, he takes what the market gives him.

Yet, one of the most curious things about the financial world circa 2009 is the yield on the 10-year Treasury note. It has fallen to under 3.5%. Despite record borrowing by the feds, lenders content themselves with the lowest yields in nearly half a century. Go figure.

The market seems to be anticipating a depression. Why else would bond yields be so low? If the economy sours...and the stock market sinks...the safe yields on Treasury bonds will seem like a good alternative. But Buffett believes the Treasury yields are not as safe as they appear. That other $900 billion has to come from somewhere. And the feds can't allow interest rates to rise significantly; that would undermine all their stimulus efforts. High real interest rates depress economic activity. So, what can the feds do?

"Washington's printing presses will need to work overtime," says Buffett prophetically. Of the two ways of financing the deficit, one is a flimflam; the other is robbery. In the great credit expansion consumers borrowed so they could buy things such as automobiles. Now, the feds borrow and bribe the voters with money to buy automobiles.

No matter who does it, borrowing for consumption is merely taking from the future. Then, when the future comes...the account has to be settled. Result: no net gain. What was consumed in one year is not consumed in the next.

Of course, the feds don't spend money the same way consumers did. Consumers wasted their money on frou-frou and watchamacallits of their own choosing. The government wastes money on different things - like turtle crossings and billion-dollar bailouts.

Not that we're complaining about government spending. We're just pointing out that it's not the same as private spending. What makes goods good is that people choose them and buy them with their own money. They get what they've got coming. But the feds are spending other peoples' money. If they get any goods at all it is practically an accident.

But what we're talking about this morning is the dollar. According to Buffett, the dollar is in danger. He's worried about the larceny, not the flim-flam. Printing up additional dollars robs savers. Each new dollar created to buy US debt makes each one already in existence - say, in a vault in the Bank of China - worth less than it was before. If that isn't true, the whole body of economic thinking from Adam Smith to Irving Fisher is nothing but a fantasy. And the only way to protect the value of the dollars held by savers, theoretically, is to withdraw the stimulus money before inflation sends prices soaring.

Buffett is an optimistic fellow. He believes that responsible authorities will turn off their dollar-printing machines in order to protect the greenback. Here at The Daily Reckoning, we're not so sure.

First, the depression is likely to be worse than people think. This will mask the effects of dollar printing. Plus, it will make the need for more dollars - more federal spending, more US debt - seem more urgent than ever. Instead of pulling the plug, they'll turn up the speed.

Second, the feds are not really interested in the health of the real economy anyway. This is an insight, which while it may seem obvious, it only came to us recently. When the feds put in place absurd policies to delay and restrain the inevitable correction, they are making things worse, generally, for everyone. But the politicians are responding to their constituents' demands. One campaign donor wants to keep his business alive. Another wants to keep his job. Still another promises the feds high paying jobs on Wall Street, after their term in Washington is over. Millions of others - more than enough to turn an election - want free pills and mortgage subsidies and so forth. When the feds try to bailout the economy, they are only doing their jobs! They're not going to stop doing their jobs - especially in a depression - just to protect foreign dollar-holders.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Warren Buffett Says American Economy is a Shambles
• The Fed Cut Rates – But How Low Will They Go?
• Is Inflation Necessary for Recovery and Growth in the United States?
• The More Money in a Financial System the Less Each Unit is Worth
• Gold is in a Bull Market

Meanwhile, oil stocks in New York surged along with crude oil. The Department of Energy in the U.S. said crude stock piles were down. This, among other things, sent front-month crude futures up 4.7% to $72.72.

By "other things" we mean that the market realises not enough money has been invested in new energy projects to meet new demand. The International Energy Agency reckons the credit crunch led to the cancelling of over $170 billion worth of oil and energy projects worldwide. This explains the feeding frenzy around LNG projects in Australia.

And speaking of that, Pluto is catching up with the Gorgon. The energy story is dominating the resource sector at the moment. Yesterday it was Woodside Petroleum saying it would triple production from its Pluto LNG plant by 2014. Pluto is scheduled to enter into production ahead of the Gorgon project, which was all over the papers yesterday.

Woodside's shares reacted to the favourable production schedule yesterday. They were nearly up 3.5% while the rest of the market stagnated. And there was movement in the eastern LNG projects too. You may have seen earlier this week that Origin Energy selected a site for its LNG terminal in its LNG joint venture with Conoco Phillips.

The final investment decision won't be made until next year. And if it's a go, the project won't begin production until 2014. Kris Sayce reckons his small cap tip is a better bet for making punters money now. It will enter production much sooner. The only big difference is that the share Kris has recommended in his Small Cap Letter is involved in a smaller project.

"The project will deliver 1.5 million tonnes of LNG per year," says Kris. "But it's going to be the first project that actually produces LNG in the region. It's located closer to the coast. And it's scalable. The LNG terminal it's building can take production from other players in the region. And it will already be up and running when other trains get into production."

Does the surge of Asian and especially Chinese interest mean a new source of strength for the Aussie dollar? Robert Gottliebsen thinks so. He made an interesting point yesterday over at Business Spectator. He wrote that, "The Chinese now know that they can invest in Australia and not face a serious currency risk. We are going to see them buy property in the eastern states and they will support our debt markets on a much larger scale."

He added that, "There is enormous concern in China about the US currency and the fact that there could be huge losses ahead for China if the American dollar falls...HSBC research shows that China does not face that risk in Australia. Global investors who want to invest in China can do so via Australia with far less risk. Accordingly, our share market is set to follow China."

He may be right. It's certainly true that trading U.S. dollars for Australian real assets (be it LNG, coal, iron ore, or real estate on the east coast) is probably a good trade for China. It has several trillion in foreign currency reserves, the bulk of which are denominated in U.S. dollars. There are going to be heaps more dollars printed in the coming years, given the reluctance of the U.S. government to either increase taxes or reduce spending in order to tame its deficits. Inflation is the way out.

Here in Australia, that apparently means more debt is acceptable. Treasury secretary Ken Henry says that because of Australia's privileged position relative to the China boom, the country can run higher current account deficits without having to worry about a run on the dollar. Henry has said Australia "might attract an even greater share of global capital flows, and quite possibly even larger capital flows in aggregate."

Because the Aussie dollar is not the U.S. dollar, let us add more debt!

There are many factors that might make Australia a desirable place for foreign capital. It has a stable political system, a fairly sensible regulatory framework, a commodity currency, and a whole lot of beach front property. But we'd be wary of using that as an excuse to run higher current account deficits, importing more than you export. It's a bad habit to get into. Just ask Warren Buffett.

Buffett wrote an op-ed in the New York Times pointing out that America's Federal deficit of $1.8 trillion is not just 13% of GDP. It's "unchartered territory." "Because of this gigantic deficit," he wrote, "our country's 'net debt' (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent."

Australia's net debt, by the way, is around 56% of Aussie GDP. This growth of that figure indicates you owe more and more to foreigners and that your own domestic growth is financed by foreign borrowing. It also means the income from your national assets may increasingly go to foreign bond holders. A high net-debt to GDP position is not a good one to be in.

"Admittedly," Buffett adds, "other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to GDP at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out."

"The Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington's printing presses will need to work overtime. Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can't come close to bridging that sort of gap."

So Buffett has admitted that you can't grow an economy out of that much debt. That is bad news for America and the U.S. dollar. But what does it mean for Australia? Well, that's a good question.

It might mean that U.S. creditors (like China and Japan) would be happy to fund Australia's modest debt levels, given the higher yield on a stronger currency. That might lessen Australia's vulnerability as a capital importer. It might even mean that interest rates have to go up less fast than Glenn Stevens currently thinks.

But does it also mean Australia is slowly becoming a vassal state to China? The economy is dependent on Chinese trade. The funding of government deficits and a larger net debt position will be dependent on Chinese capital. If the government has little leverage in the Stern Hu case now, how much more will it have in ten years if these trends continue? And is there anything that can be done about it? More on this tomorrow.

Dan Denning
for The Daily Reckoning Australia

• BHP Billiton: The Oil Company That is Not an Oil Company
• Foreign Investment in Australia, How Much is Too Much?
• Wage Pressure in China to Drive Up Cost of Goods in Australia
• Energy Debate in Australia Needs to Get Serious
• Big-picture Case for Energy Stocks is Pretty Bullish

For starters, billionaire investor/guru/jovial-grandfatherly-figure Warren Buffett has said the American economy is a "shambles." Buffett told CNBC that the worst of the financial crisis peaked late last year (we're not so sure). But the economic crisis? That's still in full flight.

"I get figures on 70-odd businesses, a lot of them daily," said Buffett. "Everything that I see about the economy is that we've had no bounce. The financial system was really where the crisis was last September and October, and that's been surmounted and that's enormously important. But in terms of the economy coming back, it takes a while."

"A while," is not a precise unit of time. But Buffett is probably right. "There were a lot of excesses to be wrung out and that process is still underway and it looks to me like it will be underway for quite a while. In the (Berkshire Hathaway) annual report I said the economy would be in a shambles this year and probably well beyond. I'm afraid that's true."

Buffett remains optimistic that eventually we'll grow our way out of this recession. He said the same thing, by the way, after the U.S. debut of "I.O.U.S.A." But that was before the U.S. stacked on several trillion more in debt to "deal" with the financial crisis.

Speaking of "I.O.U.S.A," we're hoping to bring it to Melbourne in late July for its first official Australian screening. A plan is being made. You will be alerted to this plan once it's down. We're organising what we hope will be Australia's first real frank discussion about household debt, government borrowing, and the banking sector. No holds will be barred. Stay tuned.

One more comment from Buffett. "I don't worry about deflation at all," he said. We haven't seen the entire interview. But we are presuming that means he's more worried about inflation-unless he's worried about neither, which we suppose is possible. But Buffett did say he thought the stock market was attractive over the next ten years, compared to other alternatives.

If, by other alternatives, he means cash, then maybe he IS worried about inflation and thinks that stocks are a better asset class to own than cash during inflation. He certainly can't mean that government bonds are a better bet than stocks for inflation, can he?

Enough of trying to read Warren's mind. Let's take a quick look at what the Federal Open Market Committee said today regarding U.S. interest rates. Remember yesterday we said to watch for language which tipped the Fed's intentions regarding the bond market. It all begins with the bond vigilantes these days. So what did the Fed say?

It made clear low rates-at least the Fed's target rate-are here to stay. "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Whether the Fed can talk down or manipulate long-term rates into staying dormant is another matter. But it had more to say on the subject. "As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year."

The important part here is "as previously announced." This sounds a bit like, "I really mean it. I'll do it. I'm dead serious. Don't make me buy those mortgage bonds. I'll do it if I have to. Don't push me."

In other words, the Fed is merely repeating what it said it would do earlier. It did not announce a new policy or its intention to expand quantitative easing to keep bond yields down. We imagine it would not want to advertise its willingness to keep buying bonds. That might induce a lot of selling and have the perverse effect of pushing U.S. yields up and investors into other assets.

But just for good measure the Fed repeated itself one more time. "In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

So it's a waiting game now. The Fed hopes the economy recovers this year and that it can withdraw its massive liquidity measures before they leak through into the economy to cause inflation. So far, its credit facilities have not translated into an expansion in the money supply. That's what the bond market fears (which is also why ten-year Treasury yields were up on the day).

Here in Australia, yesterday's bleak global forecast by the World Bank was immediately countered by a ray of sunshine from the Organisation for Economic Cooperation and Development (OECD). The OECD says Australia's economy will only shrink by about 0.3% this year. That's less than any other economy in the OECD. It also says the economy will grow by 2.4% next year, more than any other OECD economy.

Just how it reached that conclusion we don't know. Will unemployment peak out this year? Will housing roar ahead? Are exports to China about to soar again? What will be the engine of the Aussie economy in this recovery? It probably won't be bank lending.

Today's Australian reports that, "The Commonwealth Bank has flagged a sharp decline in its business lending portfolio as the bank admitted there would be future increases in provision charges due to the slowing domestic economy. The bank's chief financial officer, David Craig, told an investors conference in Sydney yesterday the operating environment for the bank remained difficult, but the economy was well-placed compared with its global peers."

Commonwealth Bank said it had total impaired assets of $3.9 billion at the end of the March quarter. That was up $785 million in three months. But it said the rate of growth in asset impairment slowed down. Hmm. We'll have a think on that and get back to you tomorrow.

Dan Denning

for The Daily Reckoning Australia

• Buffett Not Worried About Depression But How Recovery is Financed
• Warren Buffett is Buying Four Percent of Goldman Sachs
• Warren Buffett: People Do Not Make Money by Betting Against the US Economy
• Ben Bernanke “Respectfully Disagreed” With Angela Merkel
• Warren Buffett Travels to Europe to Seek Out Better Investments

..the cabs are black...and so is the mood.

Last week, the Bank of England and European Central Bank announced new initiatives aimed at putting some brighter colors in the economy. Both banks are going to take up forms of QE - quantitative easing.

Whoa...don't touch that dial! (A reminder for younger readers: TVs and radios used to have dials, which you turned to change the channel. Announcers would begin with 'Don't touch that dial' when they had something important to say.)

We're not going to discuss QE - promise!

On Friday, for the benefit of new readers, we were trying to explain The World According to The Daily Reckoning. Today, we continue our explanation - partly to bring new Dear Readers into the picture...and partly to remind ourselves what the hell we're talking about.

On Friday, the Dow rose 164 points. The rally is still going on. Markets make opinions, say the old timers on Wall Street. After nine weeks of rising prices, people are beginning to see the world differently. To simplify: it doesn't seem nearly as bad a place as it was a few months ago.

Oil has risen to $58 a barrel. The dollar has fallen to $1.35 per euro. And gold is at $914.

Even house prices - while not actually rising - are not falling as fast as they were before. And while people are still losing their jobs, not as many of them are losing their jobs each month as did earlier in the year.

This has led many commentators to believe that government's expensive bailout/stimulus efforts are finally working.

Toward the end of last year, the days were getting shorter and shorter. Darkness covered the land - especially in Iceland where, even in the best of times, late December offers barely enough daylight to smoke a cigarette.

And then, the authorities got up to their usual antics. They bailed out some companies...lowered interest rates to zero...and shored up the financial sector - which just happened to have very good representation in the government and its central bank - and saved the bondholders from getting what they had coming. Meanwhile, the feds made sacrifices to the market gods too. Unable to find any virgins in the financial sector, they threw the taxpayers down the well. And then they went after the savers (admittedly, there weren't many of them) and the next generation too.

At first, it seemed as if the feds had failed. Then, gradually, the light increased...the days grew longer.

And now, the mob screams: "The worst is over!" "We've seen the bottom." "Hoorah for the feds!"

But it is not likely to be so...

Here we give you the first of four Daily Reckoning dicta:

People do not get what they want or what they expect from the markets; they get what they deserve.

Of course, people would like the downturn to be over. Many are counting on it. But Mr. Market doesn't give a hoot. He's got a "Capitalism at Work" t-shirt on and a sledgehammer in his hand.

What's he up to? He's demolishing a quarter century's worth of mistakes. There are always mistakes made. Investments go bad. Businesses go under. People go broke. When many mistakes are corrected at once, it's called a 'recession.' And when an entire economic model goes bad, it's called a 'depression.'

The economic model of the last quarter century caused more mistakes than usual. It encouraged people to spend, borrow, and speculate. And each time Mr. Market tried to make some corrections, the authorities came along with more money and easier credit. Businesses that should have gone under years ago kept digging themselves in deeper. Homeowners kept running up more debt. Speculators kept taking bigger and bigger gambles. Altogether, total debt - a measure of the bubble in the credit markets and all things associated with it - rose from only about 150% of GDP when the Pontiac GTO came out, to 370% during the Hummer and Prius years.

Fish gotta swim, birds gotta fly, and bubbles gotta blow. The bubble in the financial sector - including subprime debt, housing prices, bonuses on Wall Street and derivatives - hit the fan in 2007. And what a mess!

And why shouldn't it be? Which brings us to the second of our dicta:

The force of a correction is equal and opposite to the deception that preceded it.

The delusions and absurdities of the Bubble Epoque were monstrous. Naturally, the correction must be huge too. World stock markets were nearly cut in half. Property prices too have been knocked down almost everywhere. The total loss of nominal wealth has been estimated as high as $50 trillion.

In today's paper, we find that Buffett's company, Berkshire Hathaway, made its first loss since 2001. Thirty-three banks have been shut down this year. America's leading banks say they need another $75 billion to keep their doors open. And Fannie Mae said it lost $23 billion; it will need $19 billion more to continue jiving the housing market.

Could these losses have been prevented?

Ah...certainly many of them could. If the U.S. Congress had never created Fannie Mae, for example, it never would have distorted the mortgage market as much as it did. And if the feds hadn't created the Federal Reserve Bank, it couldn't have provided so much ready money for so many speculators and borrowers. And if the Fed under Alan Greenspan had done what it was supposed to do - that is, to "take away the punch bowl" before the party got out of control - the bubble in the financial sector probably would have been much more modest.

Of course, people drew all the wrong conclusions. They thought "capitalism failed." They saw the car drive off the cliff...but didn't notice how government had twisted the road signs. Instead of warning investors of the dangerous curve ahead, the Fed's low lending rates said: 'Step on the gas!'

Dictum number 3: Capitalism doesn't always take an economy where it wants to go; but it always takes an economy where it ought to be.

Whoever was responsible for the mistakes, capitalism went about correcting them with its customary élan. It hit imprudent investors with trillions in losses. It knocked down mismanaged corporations. It whacked homeowners...and pounded housing-based derivatives to dust.

Capitalism operates by a process that the great economist Joseph Schumpeter called "creative destruction." It destroys mistakes to make room for new innovations and new businesses. Unfortunately, this puts it at odds with government...and what most people want. When people make mistakes, they maintain that they are blameless ("who could have seen this crisis coming?") and that someone else should pay for the loss.

So today, the feds, who mismanaged their regulatory responsibilities during the Bubble Epoque, are bailing out mismanaged corporations in order to protect lenders who mismanaged their money. They are determined to prevent capitalism from making major changes - in the worst possible way. What's the worst possible way? Simple. Leave the mismanagers in place. Keep the brain-dead companies alive - along with the zombie banks. Let the government take ownership of major sectors of the economy. And stick a debt-ridden society with even more debt! The feds are expected to borrow $2 trillion this year alone. From whom? And who will repay it?

We think you have a pretty good idea of who is going to end up footing the bill, dear reader.

And the fourth dicta: The severity of a depression is inversely correlated with government's efforts to stop it.

The more the feds try to delay and distract the process of creative destruction, the longer it takes to get the job done. And the higher the eventual bill.

There are only two fairly clear examples in modern history. After the crash of '29, the Hoover and Roosevelt administrations tried desperately to stop the correction. They could not make bad debts disappear, nor turn bad decisions into good ones. All they could do was to retard the necessary corrections - and cause new mistakes! It wasn't until after WWII, 15 years later, when the New Deal was largely forgotten, that the United States got back to work. Similarly, when Japan was confronted with a major correction in 1990, its politicians followed the Hoover/Roosevelt model. Over the years, an amount equivalent to almost an entire year's output was applied to recovery efforts. But all they did was to prevent and forestall the needed changes. Now, 19 years later, the Japanese economy is still in corrective mode.

Tomorrow...beware the suckers' rally...

Uh oh...we might be next. The U.K. government has published a list of people it won't allow in the country. The list includes some terrorists...but also conservative U.S. talk show host Michael Savage.

The idea, as near as we can make it out, is that Britain feels it can exclude people who nurture hatred.

So, let us make it perfectly clear: Here at The Daily Reckoning we do not hate bankers, politicians, lawyers, bureaucrats, tax collectors, gypsies, slow drivers, rich people, snitches, women, dwarfs, English twits or anyone else.

Nor do we advocate the use of violence in any form - unless it is necessary...and unless it is against small, defenseless little nations that can't fight back.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Greatness of a Depression is Commensurate to the Government’s Efforts to Prevent It
• The War On Capitalism Continues
• Feds See Every Emergency as an Opportunity
• The Return of the Cattle Market
• A Battle Between a Natural Market correction and an Artificial Attempt to Avoid it

And now, it's broke. And even politicians think they know how to run an auto company. Just read the papers. "Obama insists on changes," says one headline.

Normally, the politicos should hold their tongues...and let an industry's owners run their businesses. Alas, as of a few days ago, the politicians ARE the owners.

Here's a question:

When the government takes a majority stake in the auto business you know you are:

A) In a bad dream

B) In a bad way

C) In a bad country

D) In France

Correct answer: well, we we're not in France. But as for the rest, it could be any of them...or all of the above.

Here's an easier question. Who will the U.S. government put on the board of directors of General Motors?

A) A political hack

B) An industry hack

C) A far-sighted maverick who will shake up the business and put it on the road to growth and prosperity

If you answered "C" - you are from another planet. There is a reason neither governments, nor workers should own businesses. In the following, roundabout way, we explain why...

But first, a bit of news. As far as we can tell, the bear market rally is still on. The Dow rose 44 points on Friday. Oil closed at $53. The dollar is still sinking. And gold lost $3 to end the day's trading at $888.

Thirty-two banks have shut down so far this year in the United States. Little, mismanaged banks go broke. But big, mismanaged banks get federal money. With these subsidies and bailouts, the big banks get larger...and live to foul-up another day.

Poor Warren Buffett seemed a little discouraged at his annual shareholders' fest in Omaha. He must be nearing the end of his career. And consumers just aren't buying as much furniture, cola, and candy as they used to, he told the faithful. Berkshire Hathaway's profits were 10% below those of last year.

Swine flu seems to be disappearing from the front pages. Has it gone the way of Y2K and terrorism? Has another great disaster been averted? Might be too early to tell...

Oh you doomers and gloomers, cheer up! There's always some other disaster waiting for a headline. How about this? The Seattle Times looks at Las Vegas and sees what it calls "the next global crisis." After 10 years of drought, Las Vegas is running out of water.

The city fathers are thinking of all sorts of solutions - except, of course, for the obvious and effective one. They're planning on huge pipelines...hundreds of miles long...and sucking water out of aquifers millions of years old. But, according to the paper, Las Vegas charges only about a tenth as much for its water as Atlanta does. The simple solution is to let free enterprise provide water...so that it could be priced correctly.

Colleague Chris Mayer has been following the water crisis story since the introduction of his newsletter, Mayer's Special Situations, in 2006.

"Water is not just a problem in Las Vegas. The lack of sources for fresh water is a problem facing much of the American West, though the problem is particularly acute there and in the state of Nevada generally. Nevada is the most arid state in the union," says Chris.

"The tight water supply has implications all over the West. In Arizona, you can't build a residential development unless you find a 'designated assured water supply' that can sustain that development for 100 years. I could go on and on about this kind of thing. Suffice it to say, the American West faces a water crisis."

Maybe the increase in water prices would discourage people from planting Georgia-style grass lawns in the Nevada desert. Or maybe it would discourage people from moving to Las Vegas in the first place. But that's the thing with capitalism; it doesn't take people where they want to go...it takes them where they ought to be. That's also why people hate free enterprise so much. Where they ought to be is, often, where they least want to go. In the present example, people think they have a right to water - practically for free. They think there's a 'water clause' in the Constitution that says government is supposed to provide them as much water as they want at a price they can afford.

Most things work better when they are run by private enterprises. Too bad. Free enterprise is out of style. The days of privatizing are over. Now, everyone wants the government to take charge.

What a turnaround from a few years ago - when people thought they could solve practically every problem by privatizing it. And then, the voters would buy shares in the newly privatized companies...and we'd all get rich!

"For water, the really bad stuff hasn't happened - yet," says Chris. "As investors, it's a good place to be for a long time."

Bill Bonner
for The Daily Reckoning Australia

• Water Usage by Big Companies
• Denmark, Spain, the U.K. and Ireland Have Begun to Register Falling Housing Prices
• Best Investment Opportunities Emerge from Water, Agriculture, Gold and Energy
• Obama Has Business Plan for the Car Industry
• Ireland Going Through Same De-leveraging Process as the US

Poor Warren. He's down to his last $25 billion. And Bill Gates can barely hold his head up; his pile has shrunk to barely $18 billion.

And do a Google search of "AIG outrage" and you will get 621,000 hits.

Alas, being rich isn't as easy or as much fun as it used to be.

The rally paused yesterday. The Dow lost 7 points. It could be over. More likely, it will run for a few months. Gradually, people will come to think that this is the real thing. They'll begin to imagine that it is 2003 all over again. Of course, it's not...this market has nothing in common with the Great Rebound of 2003-2007. (More below...)

Oil traded at $47 yesterday; it is slipping toward the $50 level. And the dollar is slipping around too - it is losing ground against the euro, now trading at $1.29/$. But it is mostly steady against gold, which seems to like the $900-$950 range...for now. We have a feeling it's going to go much, much higher before all this is over.

AIG is today's main story. Everyone is appalled, outraged...or apoplectic about it. First, we under-reported the amount in bonuses paid out. The real amount is $450 million, says the Wall Street Journal...and one member of Congress charges that many bonuses were disguised as other things...and that the real total is more like $1 billion.

The average lumpenvoter has no idea how bailouts work. He was willing to believe that giving Wall Street hundreds of billions in taxpayer money would somehow make his house go up in price, but now that he sees how it really operates, he is ticked off about it. He may not understand macroeconomics, but he knows chicanery when he sees it.

Under pressure, AIG revealed what it did with the bailout money. It came as no shock to us to discover Goldman Sachs at the top of the list of recipients. Goldman's main man was in the room with the feds - the only representative of Wall Street - when the decision was made to rescue AIG. What's more, the feds' main man at the time - Hank Paulson - also used to be the top honcho at Goldman. So the fix was in. The government gave money to AIG and AIG gave it to a long list of speculators - including Goldman.

This seems perfectly natural to us. If we'd been in on the fix we would have steered some of the loot our way. But the politicians are feigning shock and horror. Senator Grassley even said AIG management should "resign or commit suicide." He later calmed down and said he didn't mean it.

But we would have simply edited his remarks, giving the schmucks at AIG a last chance to exit with honor: "Resign AND commit suicide, in that order."

Barney Frank added that "maybe it's time to fire some people." Why not? The feds own 80% of the insurance giant now. Go ahead; fire all the people you want. That's about the only pleasure a real capitalist has left to him. Reach out...and fire someone today!

Elsewhere in the news, the economy continues to deteriorate. Industrial production fell 1.4% in February. And credit card defaults are at a 20- year high.

Misters Smoot and Hawley seem to still be on the federal payroll. The news this morning is that they began a trade war with Mexico and the Mexicans have already retaliated. That's all we know about it...

But back to the tribulations of the rich...

First, Mr. Market is downsizing fortunes - fast. In the last 12 months, the average rich person has probably lost half his wealth. Not only did he own millions worth of stocks and real estate...he was also among the privileged few to get into good deals on derivatives, SIVs, hedge funds and private equity. Many of those complicated and conflicted assets have been wiped out completely. Or, maybe he was unlucky enough to count Bernie Madoff as a friend.

Second, what Mr. Market doesn't take, Mr. Politician is looking at. All over the world, plans are afoot to increase his taxes...and close down his tax havens. President Obama has already revealed his plans to soak the rich. Every other group will come out even...or better...from Obama's tax proposals. But the rich are going to be saturated...marinated...soaked to the bone.

And third, the poor rich guy has become a pariah. He doesn't get invited to charity events anymore - or even to join the guys after work for a beer. Europeans have always distrusted rich people. But in America, a rich man used to be respected - just because he was rich. People asked his opinion on politics...on fashion...on art. He was presumed to be an authority on all things and was generally treated with respect...even deference.

But now rich are seen as chumps, losers, incompetents and malefactors. Even Americans look at rich people and think they must be either stupid or corrupt.

"Le secret des grandes fortunes sans cause apparente est un crime oubli , parce qu' il a t proprement fait." said Balzac. Which has been paraphrased to "Behind every great fortune lies a great crime." Of course, he was referring to France, where it is has probably always been true. Money is dirty in France. But in America, money was supposed to be clean...innocent...honest and forthright. The richest man in town always sat in the front pew in church and stood for election to local office.

But come the depression and even the rich suffer. And unlike the starving urchins, unlucky widows and innocent orphans, no one cries a tear for the rich. Here at The Daily Reckoning we always take the side of the underdog...and always support the lost cause. So when we think of the rich...those darling people with their Italian suits...German cars...and Swiss bank accounts...our cheek gets a little moist. For we - and we alone - still admire and respect the rich. Of course, the rich are human beings too - just like the rest of us. And yes, dear reader...we still despise them as much as anyone else. When it comes to intelligence or moral rectitude, they are probably no better than the lower classes, though probably no worse. But we still admire and respect their money. Their money is no better either - but they have more of it.

Now over to Baltimore, where Addison at The 5 Min. Forecast gives a St. Patty's Day look at the Emerald Isle:

"What's the difference between Iceland and Ireland? 'one letter and six months,' or so goes a joke making its way around the Internet," writes Addison.

"Aye, on this St. Patty's day the Emerald Isle is suffering the mother of all hangovers; the embodiment of a boom gone bust.

"With official unemployment now over 10%, GDP shrinking at a 6.5% clip, a proper housing crash and a 10% federal budget shortfall, Ireland has seen it's glory days crumble into one of the Eurozone's most beaten down economies.

"Ratings agencies are on the verge of downgrading Ireland's sovereign debt, which will assuredly make the whole matter even grimmer.

"The opening joke is so pointed," Addison continues, "Irish Finance Minister Brian Lenihan is now on a global PR tour to help rekindle the world's love of shamrocks and Guinness. Despite Lenihan's denials, many expect the IMF to swoop in and become Ireland's banker of last resort."

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

Back to Bill in Paris...

It's NOT 2003. Just in case you had any doubts.

You remember 2003? After a phony recession in '01-'02 came a phony boom in '03-'07. Stocks had driven into a ditch following the crash of the NASDAQ. The Dow had fallen down to about 7500. And then, when it looked like they were going nowhere for a long time...along came Alan Greenspan's friendly towing service. In a jiffy, he winched the economy back onto the road...and it was soon flying along at the fastest speeds every recorded. The Dow went all the way to 14,000 and beyond...before crashing into a stone wall.

And now the financial media is on "bottom watch." No, we're not talking about the kind of bottom watching you do on a Brazilian beach...we're talking about looking for the end of this bear market.

"Are stocks and oil bottoming," asks a headline at Seeking Alpha.

"How will we know..." when we hit the bottom? Asks the New York Times.

The answer: we will know when we no longer want to know.

For the moment, we believe we are beginning a classic rebound. The news seems to have turned positive...along with the weather. It's sunny and warm in Europe this morning. And investors are focusing on the positive.

"IMF poised to print billions in global quantitative easing," says a headline in London's Telegraph.

All over the world, the feds are working the pumps. And investors are watching their little boats begin to rock. If history is any guide, this rebound will recover 20% to 50% of what was lost. Then, the bottom - so recently spotted and revered - will fall out.

This is not 2003. In 2003, there was no collapse of the financial sector...banks didn't fail...major companies didn't face bankruptcy...consumer spending didn't fall...house prices didn't collapse...savings rates didn't go up...capitalism wasn't called into question...there were no tax rebates...there were no bailouts...not even a stimulus plan (though the feds did spend much more money...and the Fed did cut rates to 1%).

This time it's different. This is not a recession. Not even a phony recession. It's a very real Depression with a capital D...and all that goes with it - including whole industries that go broke, a credit crunch, a big drop in consumer spending, a huge political shift toward socialism, interest rates at zero, falling prices, and widespread bankruptcies - both of households and companies.

In 2003, a quick cut in interest rates - along with a boost in federal spending - produced a fast turnaround. Within months, prices were rising again. Consumers didn't even pause...they kept spending and borrowing all the time. This time, the world has never seen stimulus efforts of such huge magnitude - and still no real uptick. This time, consumers are running scared...they're losing their jobs and closing their wallets. This is the real thing. It won't end quickly...or easily.

Here's a calculation for you. The amount of excess debt in the United States is about $20 trillion. That's the difference between the usual level debt - about 150% of GDP - and today's level - about 350%. That $20 trillion in surplus debt probably has to disappear before a true growth cycle can begin again. The best way is simply to let nature take her course. Much of it would be written off in a few months. But the feds won't let that happen. They're doing all they can to prevent assets from getting marked down...and to prevent debt from getting written off. So far, they've committed $11.7 trillion to the fight against debt deflation.

So instead of writing it off, it will have to paid off...or ultimately, inflated off.

Currently savings rates have risen from zero to about 3% of GDP. That's about $420 billion per year put to paying down the debt. Let's see, at that rate, how long will it take to erase the $20 trillion in excess debt? Hmm....about 47 years!

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• What Did the Feds Think When They Gave AIG Money?
• Temptation for the Investors
• OPEC May Cut Oil Production
• Japanese Practically Gave Away Money to Anyone Who Would Borrow It
• Debt Built Up to Levels Even Obama Says Are “Unsustainable”

Few things are as costly as free money.

When the Spanish Galleons came back from the New World with cargoes of gold and silver coins, the Spaniards thought they'd hit the jackpot. All of a sudden, Iberia had plenty of money. Historians report that the Spanish neglected their fields and their manufactures; now they had easy money to spend. Prices rose quickly. Then, when the treasure ships stopped coming, the Spanish were broke. Spain - and Portugal too - went into a decline that lasted four centuries.

In the late 1990s, America got in the habit of getting shiploads of stuff from Asia - and paying for it only with pieces of green paper. Pretty soon, Americans too neglected their own factories - though not their fields. Let the Asians sweat, they said. We'll think!

Not much serious thinking has taken place in the United States of America for the last 20 years. Instead, people preferred comforting illusions and conceited claptrap. We have the 'strongest, most dynamic economy the world had ever seen,' they congratulated themselves.

Of course, you don't need to think - not when you ship is coming in. But now that the ship is sinking you'd expect people would put on their life jackets and their thinking caps. Nope. Now they look to the government for the free money. Yesterday's news told us that Congress is now spending away $1 billion per hour.

We'll come back to that in a minute...

First, some treacherously good news: the Dow rose again yesterday...up 239 points. We're still withholding judgment, but it looks as though this might finally be the long-awaited rally. Stocks worldwide lost more than half their value without a single major rebound. We're overdue for one. Maybe this is it.

Oil rose too - to $47. It seems to be getting ready to slide back over the $50 mark.

And the dollar may have topped out. The euro rose yesterday to $1.28...while gold recovered $13 to close at $924.

As near as we can tell there is no good reason for stocks to rally. Unemployment is still rising and sales are still falling. Until those trends flatten out, there is no reason to think business will improve.

Au contraire, business conditions are worsening and companies are cutting dividends faster than any time since the Great Depression. How can stocks go up in price...when sales and earnings are falling? The only possibility would be an increase in P/E ratios. But who wants to pay more for corporate earnings now?

No one we know. Instead, investors are becoming more and more wary. Why? Because even the biggest, strongest companies in the world are reporting problems. The agencies knocked down GE's rating the other day. "What's it worth now?" asks a headline. But the same question could be posed to almost any company on the planet - conditions have changed; what's it worth now?

Last autumn, Warren Buffett commented on the solidity of his own company: "If Berkshire [Hathaway] isn't Triple A, I'm not sure which company would be."

But yesterday, Fitch took Berkshire down a notch...noting that the company had financial exposure in its insurance division that could be troublesome. Berkshire is no longer Triple A. And investors have to ask themselves: if you can't trust the best companies, run by the best CEOs, who can you trust?

We won't wait around for an answer, because there is none. The fact is the crisis has put a question mark behind all asset values.

Again, you'd expect these question marks to inspire a little serious thinking. If assets aren't worth what we thought they were worth...well, what are they worth? And what is happening in the economy that makes things so uncertain?

House prices show no sign of reaching a bottom; foreclosures are running 30% ahead of last year. And the press reports that there are 14 million empty houses in the United States. What happened to all the people who lived in them? Below...a partial answer...

Meanwhile, the free money is flowing. Taxpayers got rebate checks from the government last year - even if they hadn't paid any taxes. According to recent tallies, the feds have committed $12 trillion to freebies, bailouts, and boondoggles.

GM got a few billion. But the banks and Wall Street have been the biggest freeloaders so far. AIG has gotten four bailouts. Freddie Mac took a big bailout from the government too. But boo hoo...Freddie lost $50 billion last year, says the Washington Post, so it will need a little more help.

Freddie Mac "to tap $30.8 billion in aid as losses deepen," says the Bloomberg report.

When will the losses stop? Who knows? But chances are...not any time soon. You're going to have to protect yourself - and your assets - from these bailouts.

*** Where have all the homeowners gone...Long time passing
Where have all the homeowners gone...Long time before
Where have all the homeowners gone...Gone to motels everyone...
When will they ever learn? Oh when will they ev-ev-er learn?

There are said to be 14 million empty houses in America. Where did the former tenants go, we wondered?

The New York Times has part of the answer: they've moved into motel rooms:

"Greg Hayworth, 44, graduated from Syracuse University and made a good living in his home state, California, from real estate and mortgage finance. Then that business crashed, and early last year the bank foreclosed on the house his family was renting, forcing their eviction.

"Local officials estimate that 1,000 families who live in motels in Orange County, Calif., go uncounted in federal homeless data.

"Paris Andre Navarro, 47, and her daughter, Crystal, 11, have been living at the El Dorado Inn in Anaheim, Calif., for three years. Ms. Navarro said the $241 weekly rent makes it hard to save.

"Now the Hayworths and their three children represent a new face of homelessness in Orange County: formerly middle income, living week to week in a cramped motel room."

*** Finally, a Dear Reader with a comment:

"I have been reading your comments regularly for a past few years, during which I was a Managing Director at at a major US and, thereafter, major European financial institution. I am now semi-retired, living in the English countryside and watching the meltdown from afar. In my youth I was drawn to Austrian and Libertarian thinking and, as I progressed in the financial industry, never forgot these roots. Now I feel fortunate to have that grounding as it helps me to better understand what is really going on.

"During 2004-07 I saw the financial industry stacking up the powder kegs that would eventually blow up. I tried on occasion to warn people. But my warnings fell on deaf ears at Lehman and elsewhere, but not for the reasons you might think.

"I recall numerous conversations with senior people at various global financial firms on topics ranging from Fed policy, to the US/UK housing markets, securitisation and its potential pitfalls, the CDS tangle, and so on. One thing that is clear to me is that key people at these firms were aware for the most part what risks they were taking. They knew that it was all going to blow up someday, if not so spectacularly as it now has done. But they all believed that somehow they would be quicker and cleverer than rival firms, that they would effectively hedge themselves and they would get out first, before things got really ugly. As you well know, that sort of collective "greater fool theory" mindset is characteristic of bubbles and, if widely held, almost ensures that liquidity will dry up suddenly as markets turn for the worse.

"Believe me, they knew they were playing with fire to a much greater extent than is currently acknowledged. They blame 'animal spirits' and 'market forces' when they were, in fact, the most important market participants. No wonder a hedge didn't work if most major global financial institutions held the exact same hedge! If you are curious I can fill you in on some of the details although I suspect you know much of this already.

"In any event, I admire you and those few who are tirelessly pointing out that it was most emphatically not the free-market, but rather central banking and misguided regulation, that got us into this mess. You are doing the next generation a great service. Sadly, the current generation is probably beyond help at this point. I hope and pray that, like a phoenix, a form of proper, free-market capitalism rises from the ashes of the current conflagration."

Bill Bonner
for The Daily Reckoning Australia

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