Stocks rallied on this news.

Employment is said to be a lagging indicator. Economists tell you it’s the last thing to recover from a recession. Businesses don’t begin hiring until after they are sure the worm has turned in the economy. But right now, there is a pretty big decoupling between the stock market’s verdict on the economy (it’s all good, man) and the employment market’s verdict (it sucks, man).

Of course, a flaccid job market is not all that hinders the world’s largest economy. Far from it…

The supply of new US debt is growing even faster than the Congress makes plans to spend the money. The US Treasury is auctioning off $81 billion in new debt this week. It will sell $40 billion in three-year notes on Monday, $25 billion 10-year notes on Tuesday, and $16 billion in 30-year bonds on Thursday (which is pretty ambitious).

You have to wonder who is willing to loan money to the United States government – given the state of its fiscal and monetary policies – for thirty years at below 5%. But the Treasury is anxious to auction as much long-term debt now as it can, locking in what it believes are low rates. This is another way of saying the Treasury thinks rates will rise (creditors will ask for higher rates when lending to Uncle Sam).

In the report from the Treasury’s borrowing committee to the Secretary, the committee said it was getting a wee bit worried that the maturity schedule of the Treasury debt portfolio could be in trouble if rates go up. Specifically, it wrote that, “The potential for inflation, higher interest rates, and roll over risk should be of material concern.”

Perhaps this is why the Treasury and the Fed are considering whether to “move out on the interest rate” curve and try and set rates for longer-term debt. If the market is going to push them up, the Fed will have to push them down (as it has been doing anyway with its purchase plans). Rules are made to broken!

Take the statutory US debt ceiling for example. The Treasury’s borrowing committee writes that, “Based on current projections, Treasury expects to reach the debt ceiling in mid- to late- December. However, the government’s cash flows are volatile, and forecasting a precise date is difficult. Treasury is working closely with Congress to pass legislation to increase the debt ceiling. We will keep financial market participants apprised of developments as the debt outstanding approaches the statutory limit.”

In other words, the jackasses in the US Congress will have to pass a new law allowing the Treasury to borrow more. This would be comical if it weren’t so disgraceful. US monetary authorities continue to tell the world’s savers that the US standard of living is not negotiable, even if it means increasing public sector debt to over 100% of GDP.

But the world’s creditors may not be in the mood to negotiate anyway. We think the rise in gold is one example of creditors deciding there are better things to do with their money. And in the meantime, take a look at the graph below from the Quarterly Refunding Statement of the Treasury’s Office of Debt Management. It’s a doozy!

Source: US Treasury Office of Debt Management, Quarterly Refunding Statement Charts, Nov 2, 2009

Sorry about the size. We had to reduce the chart to get the whole thing in. In case you can’t read the fine print, it says that in the next five years, there will 73 days on which more than $20 billion in Treasuries mature and 46 days on which more than $30 billion in Treasuries mature. That’s 119 days of major league reckoning.

Normally, that debt is simply rolled over as a new (or often the same) buyer refinances it. But what do you think will happen in the next five years? The US will be borrowing more and more and probably at higher rates. Our guess? It won’t be good for the dollar.

Regards,

Dan Denning
for The Daily Reckoning

Major League Reckoning originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Something more than meets the eye is going on here. The IMF sale was part of a plan to unload 403.3 tonnes of gold. It’s halfway there, and will use the proceeds to fund itself and loans to the developing world (or perhaps Britain and America when they go broke). But what else is going on?

In the past, large sales of gold – mostly by European central banks – swamped the gold price and kept it in check. Why did they sell?

The central bankers believed they had too much gold on their balance sheets doing too little work. In other words, these thoroughly modern bankers would explain, “Gold pays no interest.” So they thought it “prudent” to exchange their gold reserves for interest-bearing assets like Treasury bonds. So far, that’s been a horrible trade…and it is becoming an even more horrible trade as gold advances from record high to record high.

Nevertheless, the central bankers of the West continue to unload their gold reserves to the central bankers of the East….

India’s central bank is now the proud owner of 557 tonnes of gold. That gives it the tenth largest gold holdings among central banks. But it probably isn’t finished. Gold makes up just six percent of India’s foreign exchange reserves. There’s plenty of room for that to grow.

But don’t forget China. China has $2.3 trillion in foreign exchange reserves. But 70% of those – or $1.6 trillion – are in US dollars. It owns over just 1,000 tonnes of gold. That makes up less than 2% of China’s reserves and makes China the seventh largest holder of above ground gold. In fact the gold exchange traded fund (NYSE:GLD) owns more gold than China. France, Italy, the IMF, Germany and the United States round out the top five (from fifth to first).

What this tells you is that China could double (and then double again) its gold reserves and gold would still make up less than 10% of its total forex reserves. Compare that to 66% in Italy, 69% in Germany, 70% in France, and 77% in the US, according to official numbers. So what’s the big deal?

There will always be a threat that European Central Banks release gold supply on to the market. In fact, European central banks just renewed a five-year agreement (including the IMF) to sell down a maximum of 400 tonnes of gold per year from their holdings. They’ve agreed to this to disgorge their gold in an orderly fashion.

But it would not surprise us to see the Europeans fail to sell the gold they’re allowed to sell under the agreement. Our old desk mate in London, Adrian Ash (now with Bullion Vault) is at the London Bullion Market Association’s annual meeting in Edinburgh. Word from UBS analyst John Reade, also at the meeting, is that European Central Bank official Paul Mercier reckons that official holders of gold will, “no longer be net sellers of gold.”

As we predicted earlier this year, the European central banks would rather hoard their gold than sell it in a rising market. There may be a price at which they do sell it, in order to pay down sovereign debts. But psychologically, the fact that central banks want to own gold and not sell it is pretty important.

Also, it shows you how the balance of economic power in the world has shifted East. True, the European banks can still dump gold on to the market to drown the price. But between the ETFs, central bank buyers in India and China, and the average man on the street in Beijing, Mumbai, and elsewhere, there are more buyers of gold now than sellers.

And if we were right yesterday that the GFC is slowly morphing into a sovereign debt crisis, then the case for gold is that much stronger. This explains why gold futures were up by nearly 3% overnight and Old Yeller hit a new high at US$1,084.90.

The only worry? So many hedge fund managers and pundits are singing the same tune: long gold and short US Treasuries. These feel like “crowded trades.” So as a contrarian, you’ve got good reason to be a little worried about becoming a victim right about now.

Nevertheless, in the long term, the end of the Super Cycle in fiat money results in the re-monetisation of gold. That is what you’re seeing now. And it’s probably what you’ll see for a few more years. It also ought to benefit other precious metals, and of course, precious metals shares.

The End of the Super Cycle in Fiat Money originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

It’s not technically a new decade yet. But if the trade of the last decade was to sell stocks and buy gold, then maybe the best trade for the next 10 years is to sell bonds and buy energy. Gas, coal, oil, conventional, unconventional, renewable, alternative. You have a whole portfolio of choices.

Gold is no longer as low as it once was. But it’s still not as high as we expect it to go before it starts to look foolish. Meanwhile, today’s government bond market looks an awful lot like the stock market circa 2000. You’re seeing a generational high in bonds. It’s another version of the “high-low” strategy.

This time around, though, we would add energy stocks to the mix, along with gold… There is probably some truth to the fact that oil’s latest move is driven by investment demand more than, say, demand growth in the real economy. But investors ARE looking for ways to profit from U.S. dollar weakness. Oil is liquid and popular. In the long run, it’s the smaller-than-expected oil supply growth that will drive the market.

The Pair Trade of the Next Decade originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

What a battler that Dow is. It’s got nothing on the S&P 500 though. The S&P is up 28% in the last thirty-three trading days. It hasn’t done anything like that since the 1930s. However the index did close down for the week. That broke a six-week run of gains.

One more note about that. Four-week winning streaks of ten percent are more are generally followed by much smaller gains or losses over the next four weeks, according to the analysts at Bespoke Investment Group. Their research shows that in the four weeks following a four-week rally of 10% or more on the S&P, the index followed up with average gains of 1.87%.

How about one more note about that. There were two four-week rallies of more than twenty percent, according to the same research. The S&P 500 surged 54.2% in just four weeks by early August of 1932. Over the next four weeks in went up another 30%. Then, in April of 1933, the index provided an encore to one four-week surge of 33.8% with another surge of 19.2%.

So there you go. What we do we make of all that? Well, it shows you that even in the middle of the Great Depression, the market was capable of staging mammoth rallies that would tempt investors back in. No doubt those were extremely tradable rallies. But they were followed by lower lows once the forces of economic and earnings reality reasserted themselves on the collective mind of the market.

This time will be different because it’s always different. But if you’re wondering if the stock market is flashing a recovery sign for the economy, you might want to take a look at insider selling. The insiders are selling this rally, according to Data by Maryland-based Washington Service. That outfit says the during the S&P’s 28% climb from twelve-year lows on March 9th, CEOs, directors, and senior officers of U.S. corporations sold 8.3 times more stock than they bought.

Not that there won’t be others. But behind the scenes, other things are happening which are going to drag on stocks.

One of those things is that many of the world’s sovereign governments are in the process of going broke. Spain, Ireland, Greece, and Portugal have all had their sovereign credit ratings downgraded by the ratings agencies. These countries face different challenges like burst property bubbles, declining government tax revenues, and banking sectors hobbled by massive bad loans. But what they have in common is that their respective governments have responded to the crisis by ramping up borrowing to credit-rating ruinous levels.

The scale of global borrowing plans is pretty breathtaking. And what you begin to wonder is a simple question: where is all the money going to come from? Or, to quote David Gray in “Nightblindness”, “What we gonna do when the money runs out?”

For example, the UK’s Debt Management office, which issues bonds on behalf of the British government, says that British bond sales between now and 2013 will exceed £696 billion. The Guardian reports that it will be more like £815 billion, according to figures from Deutsche Bank.

Do you think private investors are super excited to loan the British government money when the British economy is expected to contract by 3.5% this year? Under the budget revealed last week by Chancellor of the Exchequer Alistair Darling, the UK will borrow £175 billion this year alone, or about 12.5% of British GDP. Over the next five years, public sector debt would rise to 76% of British GDP from its current level of 46%.

Gee. That is a lot of borrowing. Britain is a country drowning in debt. Adding more millstones around its neck would not seem to improve its chances of paying that debt down. You could pay it down by, say, generating national income from exports.

S&P’s ratings agency keeps track of the sovereign debt to income ratio. If a country exports a lot of finished goods or raw materials, the government benefits from tax and royalty revenues. These monies are used to service the sovereign debt.

But if you’re not generating large export revenues, then you find a big gaping hole in your budget where royalty and tax revenue should be. Maybe that’s one reason Britain’s new budget raises tax rates on high-income earnings from 40-50%. What you gonna do when the money runs out?

If Britain’s government thinks it can make up for disastrous public finances by raising taxes, it’s probably making another in a long line of stupid mistakes. The high-income earners who would face the big tax increase are exactly the same people getting fired from their jobs in the City. This shows, once again, that building an entire national economy around high finance puts you in all sorts of trouble.

But wait. Maybe the high-saving nations of the world will bridge the gap between British expectations and financial reality. We wouldn’t count on it though. Remember the big hoopla from the G20 meeting in London when it was announced that the International Monetary Fund’s funding would be tripled to $750 billion?

That funding is desperately needed. The IMF itself reckons it will have to dole out some $187 billion in new loans to national governments just to ride the current phase of the global financial crisis. But a key piece of information was left missing in London. How would the IMF be funded?

The G20 finance ministers met in Washington to sort that out. And the early indications are that the IMF will be funded by issuing bonds sold to high-saving nations. If this is true, it’s a victory for the developing world and a defeat for the U.S. and Europe. The U.S. and Europe were both pushing for a direct cash injection funding method. In other words, they wanted China, Russia, Brazil, and India to use their foreign currency reserves to fund the IMF.

But the BRICs batted that proposal away. So now the IMF plans to sell around $500 billion in bonds. They will be denominated in the quasi-currency the fund uses internally (the special drawing rights, or SDRs that both Russia and China have floated as a possible new global reserve currency).

How the bonds actually work still has to be sorted out. But the internal logic of the whole arrangement is now clear: creditors hold the whip hand. Debtors are going to get whipped. The balance of power in the global economy is clearly shifting from the borrowers and spenders towards the savers and producers. Advantage BRICs.

Disadvantage Gordon Brown and Barack Obama and probably Kevin Rudd too. With the existing debt-to-GDP ratios in Britain and the U.K., we reckon it is going to be impossible to fund further expansions of financial bailout programs and welfare state programs without much higher interest rates (borrowing costs).

You can avoid the borrowing problem for a while by soaking the rich with higher taxes. You might also use climate change hysteria to tax carbon (really an indirect tax on consumers). If both happen this year and the result will be even more rapid economic contraction. They will be this Depression’s equivalent of Smoot-Hawley: exactly the wrong thing to do, done at the worst possible time.

Of course the easy out, we feel obliged to point out, is not to borrow the money at all or tax it from your citizens. You could just print it instead. But this tends to unleash hyperinflationary pressures which also tend to destabilize civil society. It’s better to avoid this if you can.

Either way, there is no avoiding the reckoning. Right now, you could make a compelling argument that the value of credit-backed assets is falling so fast that government steps to prop them up simply won’t (or can’t) work. Credit deflation rules the day. The formidable fiscal and monetary stimulus measures are disappearing in the maw of asset deflation while the world goes broke trying to prevent it.

If this is right, and it’s something investors take the time to notice, stocks are going to make lower lows again. A lot lower.

Regards,

Dan Denning
for The Daily Reckoning

What Happens When the Money Runs Out? originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

*** A 211 in progress…resources stage biggest rally in 33 years…

*** Lehman left at the altar…bring out your dead…and more!

What a difference a day makes. Or does it? Commodities are on the verge of their biggest one-week rally in 33 years, according to Bloomberg. Gold was up US$25 yesterday (2.7%). Oil rallied five bucks. The Reuters/Jeffries CRB Index tacked on 3.7% yesterday alone. If it can keep itself together today, the index will be looking at a one-week gain of 6.7%.

So is this the second coming of the commodity bull market? Or is it just a bear market rally in what is now a bear market in resources? The answer matters. If the ’short-dollar’ trade is fully liquidated, then the dollar’s surprising rally may be over and the decks clear for commodities to resume their long-term ascent.

Let’s not forget that the resource bull began in 2003. That puts the recent price action in an altogether different light – a correction in the middle of a long-term rally. But let’s not get into an argument over where the market is headed. Only it knows. And it well tell us soon enough.

Instead, perhaps we should keep an eye on what started the whole resource rally in 2003, namely, a lack of investment in supply and brand new growth in demand. That’s how resource- and China-bull Jim Rogers sees it. “Until either a lot of supply comes on stream or the economy collapses, the bull market will continue,” Rogers told Bloomberg.

*** Some controversy from yesterday’s Daily Reckoning, in which we quoted Detective Harry Callahan. “I thought the Punk did reach for it and got his head blown clean off,” a reader writes in.

Incorrect.

If you go watch the whole scene that inspired yesterday’s Daily Reckoning, you can confirm it yourself. The punk doesn’t go for the gun. He does say to Harry, “I gots to know!” Harry pulls the trigger on his revolver…and nothing happens. He fired six shots.

By the way, if you do watch the whole scene, you’ll find it helpful in describing today’s high financial crimes and monetary misdemeanors. Harry tells his buddy at the diner to call the cops and report “A 211 in progress.” A 211 is California police code for a robbery.

We don’t recommend it, given how humorless bureaucrats are today, but it would be fun to call your Congressman and report a 211 in Washington, D.C., where taxpayers have been getting robbed at gunpoint for years. When you and I commit that kind of crime, it’s called armed robbery. When Congress does it, it’s tax legislation.

Here are some other useful cop codes to know: 470 is a forgery (I’d like to report a 470 at 20th and Constitution Avenue in Washington, D.C). A 484 is theft (you could call that in from anywhere in D.C.). Or, if you’re on Capitol Hill, call in a 594. That’s the code for Malicious Mischief.

*** It’s been over a year since Jim Cramer’s famous meltdown on CNBC. We watched it at the Old Hat Factory today for grins. But seriously, the ’short-financial trade’ is tired, but clearly not dead yet. Stocks that have fallen 85% from their all-time highs can still fall 100% from their current high. It’s the kind of fall all financial Humpty Dumptys want to avoid.

For example, today’s Financial Times reports that Lehman Brother’s is trying to sell pieces of itself to foreign investors before having to report another $3 billion loss in early September. Lehman has already reported nearly $12 billion in losses since the onset of the credit nightmare. Its stock has fallen by 85%. And the FT reports that talks to sell 50% of itself to the Korea Development Bank and China’s Citic Securities fell through because both bidders said Lehman’s asking price was far too high, given the distressed state of its assets.

You get the feeling Lehman is like a man so desperate for cash that he’ll sell certain vital bodily organs for cash. The commercial real estate portfolio is valued at $40 billion. The wealth asset management group, $10 billion.

The trouble is that there aren’t many organs a man can really do without. You can part with a kidney, your appendix, a gall bladder, and maybe some bone marrow, or other bodily fluids. But try to donate your brain, your heart, or your lungs and you’ll soon be a corpse, where the sum of the parts are worth more than the whole. Once people realize that, Wall Street is going to look a lot like this.

During pandemics and plagues (so we’ve read), you dig graves to bury the bodies (or leave them lying in the street if it gets really bad). While a bull market in gravediggers is good for gravediggers, we think investors should prefer a different kind of digging…for world-class mineral deposits.

That, by the way, is why your guest editor jumped ship from London to move to Australia in 2005. Having sussed out the big picture (sell paper, buy stuff), we wanted to find good ’stuff’ to buy. We’re not alone. Canadian mining legend Robert Friedland was in town a few weeks ago, talking up the copper prospects of Ivanhoe Australia Limited.

Friedland’s business strategy is simple. Buy a distressed asset. Front up the money to drill it like nobody’s business. Demonstrate that it’s worth a lot more than you paid for it. Then find a JV partner to front up the rest of the capital to make it a producer.

Friedland is also a big fan of “polymetallic mineralization,” a kind of selling Peter’s copper to pay for Paul’s gold production. When you have a world-class polymetallic deposit, you can use the cash flow generated from one metal to sustain, or at least offset the production costs, in another.

Friedland thinks he’s got a world-class project going at Mount Isa in Queensland. “The Mount Isa mining district is one of the top five mineralized districts on planet earth,” he told the local paper. “It doesn’t have to apologies to anyone. There’s the Witwatersrand in South Africa, there’s Norilsk in Russia, there’s the Cadillac district fault in Canada, there’s the main structure in Chile. This is one of the great mining regions in the world.”

Friedland is clearly on to something. He points out that these great new ore bodies of the mining world will replace many tired, old, bed-ridden mines that are nearing the end of their productive life. “Our view, and we talk to Rio Tinto about this a lot, is around the year 2012 or 2013 we are going to have a crisis in copper because a lot of the great copper mines are like little old ladies lying in bed waiting to die.”

Younger mines will have plenty of cost blowouts (see BHP’s Ravensthorpe nickel project). They will have to endure volatility in underlying commodity prices. But they have one thing the older mines don’t: a lot of ore in the ground. That’s worth something, especially at today’s resource share prices.

How are we playing it here at the Daily Reckoning’s Australian outpost?

While Frieldand looks for copper at Cloncurry, we’ve been targeting our investments to black coal and coal-seam-methane in Queensland, new uranium mines in South Australia (the only State which is permitting new mines right now), and, most importantly iron ore, vanadium, molybdenum and rare earth juniors in the vast expanse that is Western Australia (especially in the Pilbara region where we’re headed next week. A full report will follow).

Regards,

Dan Denning
The Daily Reckoning

August 22, 2008

Dan Denning is the editor of The Daily Reckoning Australia and The Australia Resource and Mining Report.. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected “big-picture” investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.

We are about to witness a huge drama – one that will, ultimately, determine the fate of the United States of America…and the whole human race.

Before us is a clear and present danger. There is no doubt about it. Anyone who cares to look can see it. If something is not done to protect ourselves against it, the results will be either disastrous or fatal…we’re not sure which.

This week, Addison’s movie I.O.U.S.A. opens in 358 theatres across the nation. It is not merely a documentary film…it is also an expression of hope for our species. The question at hand – the real theme of this monumental drama – is whether a group of people can change the course of history.

You see, dear reader, the U.S. is in a fix. Nothing unusual about it – nations turn into empires (when they are unlucky)…then, they overstretch…they overspend…they overdo it. According to former U.S. comptroller – and the star of I.O.U.S.A. – David Walker, the U.S. government was in over its head by more than $50 trillion in 2007. Unless action is taken, the country will go broke.

Everybody knows that is true. But so far nothing has been done to correct the situation. Too many people in too many positions of power – including the lumpen voter himself – have too many reasons to want the system to continue unchanged. These people are getting something for nothing – and hoping to put the costs onto the next generation. But if the expenses continue to build up…the whole mountain of debt will come tumbling down.

Your editor is proud to have contributed to the movie. It was based, originally, on a book he wrote, with Addison, Empire of Debt. And he has a small speaking role in the film itself.

“I like what you say in the movie,” says a friend who saw the preview. “But you look terrible. You look like a pervert.”

In the film, we point out that empires always overstretch…and always collapse. Looking at history, we see that this story usually plays out as a tragedy – usually accompanied by defeat on the battlefield and national bankruptcy. Nevertheless, the Peterson Foundation is spending a billion dollars, according to press reports, to try to give our own “Made in the U.S.A.” version of this old tale a happy ending. If people can be made to understand the problem, they will do the right thing…or so they believe.

And there is the question: can right-minded, well-meaning people really change the course of history? Is that the way it works…?

We will see, dear reader…we will see.

*** Meanwhile, in Lindau, Germany, a group of 14 Nobel Laureate economists have gathered to discuss the world’s problems. Myron Scholes, who won his Nobel for his work on derivative pricing, said the financial crisis was “not over and I’m not exactly sure when it’s going to be over.” There will be “lots of business failures,” he went on.

Joseph Stiglitz described the cause of the problem as a “massive failure of the brains of the economy.”

Nobody was impolite enough to mention that many of the biggest brains were in the room…and that they had created many of the bubble’s biggest delusions.

*** Our party ended last night about 3 AM.

“This whole place is like a giant pile of tinder…and everyone in the room has a match…” said Elizabeth. More to come…

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

Clear and Present Financial Danger originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

*** Helicopter Ben and Bazooka Hank…Fire at will…

*** Buying common for less than intrinsic…and more!

Greetings from the Lucky Country. We are hard at work where the rubber meets the road in the China-resource boom (the coal/iron ore/gold/bauxite/vanadium/molybdenum rich Aussie outback).

Along with you, we wish the U.S. crew and Bill best of luck in releasing I.O.U.S.A. into the wild today. It’s a timely movie on an important subject. And Addison has much better hair than Al Gore.

In the meantime, the markets are in full swing. And since the sun never sets on The Daily Reckoning Empire, allow us to take a look at the scene and tell you what we see: a gunfight.

First, it looks obvious now that Henry Paulson is outgunned. Remember in July the U.S. Treasury Secretary said that if it was clear to the market that the Treasury COULD buy convertible preferred shares in the GSEs, it would probably restore order and prevent any more naked short selling and the total collapse of the U.S. housing market. Taxpayer money would not have to recapitalize Fannie and Freddie.

Paulson told Congress that a new regulatory arsenal for Treasury and ‘Helicopter Ben’ at the Fed would be enough to turn the psychological tide (ignoring the fact that it was solvency problem, not simply a poor frame of financial mind).

“If you have a squirt gun in your pocket,” Paulson told the Hill, “you may have to take it out. If you have a bazooka in your pocket, and people know you have a bazooka, you may never have to take it out.”

Freudians discuss.

In the meantime, to paraphrase Jim Malone (Sean Connery’s Irish Cop in The Untouchables), never bring a squirt gun to a gunfight, Mr. Paulson. What the market really wants to know is what the Treasury is prepared to do. And so the market has called Paulson’s bluff. “What are you prepared to do,” it asks?

*** Shares of Fannie Mae fell 26% yesterday, while cousin Freddie was off 22%. The death/nationalization watch for the GSEs is now on round the clock. But what does it mean for U.S. investors? And what happens next?

As the Barron’s story pointed out this weekend, both companies are effectively insolvent. But the charade that everything’s just fine continues. One reality check may come soon. Fannie has nearly US$120 billion in debt that matures by the end of September. Freddie has US$103 billion in debt.

Can the GSEs roll it over? Who’s going to buy it? The Russians? Central banks? Private equity? Bueller? Anyone?

If the GSEs can’t fund their operations or roll over their debt, what point is there in having a government sponsored mortgage lender that cannot provide liquidity in the secondary mortgage market? We shudder at what this means for the U.S. housing market…but the phrase ‘lower prices’ comes to mind.

Facta, non verba. Deeds, not words.

Paulson hoped that by publicizing the fact that the Treasury could buy equity in the GSEs and recapitalize them, it wouldn’t actually have to do anything. He wanted all of the benefits without any of the risks and actions. That pretty much sounds like the ethos of America’s financial economy in the early 21st century.

Harry Callahan had a .44 Magnum, the most powerful handgun in the world. And the punk he was chasing down didn’t know if Dirty Harry had fired five shots or six. It was a gamble the punk didn’t take because the magnitude of an imprecise calculation would result in a large hole in his head.

The difference here is the market knows that without direct nationalization, the GSEs won’t last the month, and perhaps not the week. Common equity shareholders (those that are left) are headed for the gallows. This particular verbal weapon: “Hey if we really need to, we’ll buy $25 billion in preferred convertible” – ended up firing blanks.

*** But what happens if the Treasury steps in now? We don’t know yet. We don’t know if it will restore any stability to the mortgage market. We’re pretty sure it won’t arrest the fall in U.S. home values. It may even precipitate a blow out in the spreads on GSE debt versus Treasuries, forcing the Feds to bring GSE-guaranteed debt onto the taxpayer balance sheet.

About the only thing you can be reasonably certain of this week is that the direct assumption of GSE liabilities should be a negative for the U.S. dollar. Even if the Feds reorganize the company, liquidate the riskiest assets, and refloat it as a public company…there’s a lot of uncertainty for two of the largest financial institutions in the country. Markets don’t like that.

On the other hand, there is always the remote possibility that the appearance of a resolution to the decline and fall of the GSEs will give the stock market a shot in the arm. Irrational rallies are frequent when you are in a permanent state of crisis, as the financial markets now seem to be.

But it all seems to be reaching a crescendo this week, doesn’t it? In the bigger picture, that crescendo sounds like this: debt-financed consumption is not a long-term strategy for economic success.

A minor, but building theme, might be this: buying common stock for less than underlying value (intrinsic value, net tangible value, or earnings power) is a sensible investment strategy.

Translation: keep your eyes on the resource prize. All stocks (commodity stocks included) are in for some volatility as the financial markets wait to see which dominoes fall next. But the selling in equity markets simply makes some resource shares a lot more attractive. This is assuming, as we do, that the trends of urbanization and industrialization and rising per capita incomes in the emerging world will not be derailed by the collapse of America’s Ponzi finance).

*** One interesting question: High in their bazooka-armed helicopter, do Paulson and Bernanke have quick enough trigger fingers to prevent deflation in financial assets from precipitating more selling in stocks and more failed small and regional banks (as the assets on those balances are market to market and liquidated)?

Our guess, although it is not a happy one, is that they do. The Fed is becoming a buyer AND a lender of last resort. It will manage the great collateral laundering in the financial markets, exchanging Treasuries for mortgage-backed securities and other dodgy debt. It can do this by expanding its balance sheet as much as it needs to in order to accomplish the task, something it has not yet begun to do

“I have not yet begun to defile myself,” as Doc Holliday says in Tombstone.

*** Meanwhile, we don’t reckon there’s any real need to worry about “pushing on a string.” That phrase refers to the inability of Fed policy makers to get money into the system by lowering rates.

The futility suggested by that metaphor is based on the presumption that a middle-man, the bank, is necessary to get credit and new cash into the hands of people who will use and abuse it. If the banks won’t pass the Fed’s easy credit on to consumers and corporations, then interest rates as a tool for deflating away debts aren’t effective. So the theory goes.

But the stimulus package from last year showed that the government is more than willing to bypass the banks entirely if it needs to. Treasury can simply write checks to Americans, or, through the wonders of the Internet, make direct deposits into your bank account. That’s how our stimulus check arrived this year…although that probably means the money can be taken away just as quickly and easily as it was given, can’t it?

Drug dealers always give away free samples to get users hooked. After that, it’s easy. Debt is addictive and destructive. That’s what makes the behavior of our money pushers so revolting and morally reprehensible. They’re a bunch of pushers in suits.

Mailing checks to Americans is a direct stimulus. But it’s a desperate measure. When you are that transparent about so-called “wealth creation” and “economic growth,” the nature of the system is exposed for anyone who cares to see it. Markets care.

That means it probably can’t go on for long until people begin to lose confidence (which happens when you lose purchasing power quickly). Dollar-denominated assets should fall as Bazooka Hank fires away. So should the dollar. Gold and silver, we reckon, have taken plenty of heavy fire in the last month, but will come out of all this looking like they always d shiny, durable, and like real money.

But even then, there will be another wave of fiat fraud. Public spending can be ramped up indirectly with an increase in the kind of massive public works that FDR pursued in the 1930s. President Obama/McCain better start working on some new agency acronyms.

National Rail System (NRS)? Check! New Manhattan Project For Oil Shale (NMPFOS)? Check! A War To Rebuild America’s Infrastructure (WTRAI)? Check!

The checks are in the mail America! Spend all you want. We’ll make more!

Our point?

The GSE nationalization may be a kind of starter’s pistol which causes the Fed and Treasury to roll out all their inflationary guns…and fire at will. Stocks appear to be caught in the crossfire. They’re falling as financial assets deflate. But some stocks have tangible assets. What does that mean for resource stocks? More on that tomorrow.

Regards,

Dan Denning
The Daily Reckoning

August 21, 2008

Dan Denning is the editor of The Daily Reckoning Australia. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected “big-picture” investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.

What’s going to happen to the mortgage twins – Fannie and Freddie? Yesterday, investors got nervous. They wanted to know. Would the feds officially nationalize them? No one believes the two will disappear. But no one knows on what terms they will be saved either. Both stocks sold off yesterday – with Fannie taking a 27% whack…and Freddie getting hit for a 22% loss.

The feds let it be known that they stood behind the two back in 1968 – when they were set up in their present form. They were no longer on the government’s financial books, but every lender knew they wouldn’t be allowed to go broke. So far, Treasury Secretary Hank Paulson has counted on that implicit guarantee – along with a long line of credit – to keep the two going. But now that investors are selling off the stock, he may have to come up with some real cash to put on the equity side too.

As reported here – we still have trouble believing it – Fannie and Freddie are each in the red by about $50 billion. They’re about $100 billion short, in other words. And judging by yesterday’s trading, private investors are in no mood to ante up. Which leaves good ol’ Uncle Sam. He’s not very bright; but at least he has very deep pockets…and a printing press in the basement.

But that still leaves an open question: the feds may be forced to take back Fannie and Freddie (they were publicly owned prior to ‘68), but at what price? At $10 a share? Or $2 a share?

Apart from Fannie and Freddie, stocks generally rallied yesterday. The Dow rose 69 points.

Oil rose to $116. Gold rose too – to $822.

Gold is down nearly 3% for the year. But our Trade of the Decade is still, technically, up – since stocks are off 14%.

Gold is the “the epitome of human stupidity,” said an opinion in the Telegraph newspaper. “A metal that is dug out of the ground at great cost to be reinterred in bank vaults as a protection against the same stupidity as caused it to be dug up in the first place.”

The writer is right. Gold is useful because humans are stupid. That’s why it is always useful; because humans are reliably numbskulls. And it is particularly useful when humans are particularly stupid. Remember, a correction is equal and opposite to the deception that preceded it. When people have deceived themselves in an especially monumental way, the following correction is a doozy. And that’s when you want to have some kruggerands in your pockets and a little bolt-hole in South America.

We never know what will happen, but we’ll stick with our Trade of the Decade a while longer – just to see how it turns out.

*** What else happened yesterday?

Word came that more students are choosing community colleges; analysts believe it is because they are cheaper.

GM is said to be giving up its sponsorship of the Oscars for obvious reasons – it’s running out of money. And shopping malls are finding it harder to bring in customers – partly because people are not shopping as much as they used to and partly because they’re not driving as much as they used to.

Of course, there’s a long list of things that aren’t what they used to be – house prices, stocks, emerging markets, consumer spending, bank lending, Wall Street bonuses…and so forth. Our guess is that the list is going to continue to stretch.

With that, we say goodbye for today…we’ve got to get ready for the big party – at which, your author gets to make a fool of himself twice. First, when he gives a short welcome speech, in French…and again when he performs a few songs with the band. He is a terrible musician under any circumstances, but in front of a crowd, after a few drinks, he is pathetic.

Your editor has only two good qualities. As you know, he is extremely humble…even if he is insincere about it. More importantly, he also doesn’t embarrass easily.

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. In lieu of a Guest Essay today, we hand the reins over to Dan Denning reporting from Melbourn, Australia for some additional notes from Down Under.

The Golden Value of Reliable Numbskulls originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

It happened about six days before I expected it, but at long last the hardball tactics of iron ore giant Rio Tinto resulted in an 85% increase in iron ore prices this year. It happened earlier this week, after eight months of intense and sometimes rather unfriendly negotiations. The consequences could be very friendly for investors, though. More on that in moment.

But let me just repeat that in case you missed it – with the stroke of a pen, the value of a commodity exported by Australia went up 85%. Not even the oil market moves that fast!

The Australian resource boom is rapidly becoming one of the biggest missed boats in American investing. There are staggering (and growing) numbers being posted by Aussie commodity exporters. Since it is an election year in America and your senses are being assaulted (and likely offended) by noxious fumes coming from politician’s mouths, let me remind you of the extraordinary story taking place here in the Lucky Country.

Just yesterday, the Aussie organization that tracks these things forecast 40% year-over-year growth in the value of Australian mineral, energy, and farm exports. Can you think of many companies that report 40% earnings growth year over year?

GM? Washington Mutual? Citigroup?

Led by 21st century blue chips like BHP Billiton, Rio Tinto, and Woodside Petroleum, Australian companies will export over A$212 billion worth of coal, iron ore, gold, crude oil, copper, and LNG (to name a few commodities) next year. These booming exports are evidence of the structural revaluation of global resources. And the booming stock prices of resource producers represent the structural revaluation of those stocks (once cyclical, now more like growth)

Gold to India. Coal to Korea and Japan. Iron ore to China. Copper, uranium, rare earth elements, and a host of other base metals and bulk commodities…they are all on big boats to points North and East. This is why American investors cannot afford to ignore the story any longer.

By the way, thanks to a huge spread in short term interest rates (2% in the U.S. and 7.25% in Australia) the Aussie dollar is nearly at parity with the greenback after rising 70% in the last four years. The strong Aussie currency derives much of its strength from the roaring commodities market. And it’s that commodities market that is lately under scrutiny from some investors.

The numbers above suggest that the commentators who are calling for a top in the commodity cycle are actually complete morons. But rather than name calling like a candidate for national office, let me suggest that the commodity market has evolved beyond a simple boom-bust cyclical analysis. It is still boom-bust, but with a twist.

No. I am not suggesting that, "This time it’s different." The basic economics behind the business (and/or credit) cycle are as valid as ever. Early business investment based on real demand leads to good times. Good times lead to easy credit. Easy credit leads to more investment (some of it very bad).

As money and credit expand, prices rise. Rising prices attract new investment from commodity producers. Eventually supply exceeds demand, credit tightens, and the cycle of growth ends in inflation in energy that destroys demand.

Is that where we are now?

Sort of.

There is a popular theory here in Australia – where I moved in 2005 for a front row seat to the resource boom – that China will suffer a post-Olympic slowdown. It’s what happened in Sydney after the summer games there in 2000.

This theory nicely fits another theory advanced by other analysts that China’s industrial boom is almost entirely reliant on American consumption. If the credit crisis sinks the American consumer economy in the second half of 2009, China won’t be able to sell anything to America. And if Chinese producers can’t sell finished goods to American consumers, they won’t need Australian raw materials!

Poof goes the resource boom!

The only trouble with that theory is that it’s complete hogwash.

American’s who believe that China’s boom is utterly dependent on unsustainable patterns of American consumption are sadly misinformed, or deliberately in denial about the changing structure of the global economy.

The facts are the facts. And what are the facts? The urbanization and industrialization in the developing world is hugely resource intensive. These people (in China and India and Brazil and the Middle East and Vietnam and Malaysia) are not building economies to service the whims and fancies of American consumers.

They are building sewers, bridges, factories, cars, roads, railways, airports, power plants, grocery stores, movie theatres and probably even Wal-Marts. The studies here in Australia by both the resource companies and analysts have shown that even Australian resource firms badly underestimated the intensity of demand for Australian resources.

Much of that demand comes from steel for infrastructure, residential, and commercial real estate. Australia has some of the world’s richest ore bodies, from the high-grade iron ore of the Pilbara, to the black coal in Queensland’s Bowen Basin, to Olympic Dam in South Australia (home to 17% of the world’s known uranium reserves).

In the 1960s and 1970s, Japanese and Korean companies were on the ground and in the Outback, looking for joint venture deals to secure long term access to Aussie resources for their post-war, industrializing economies. It is like that today, but on a much, much greater scale.

Today, the place is filled with Chinese, Russians, Indians, and even nomadic American newsletter writers. Australia is as big as the continental United States. Much of it remains unexplored. But there are plenty of investors on the ground from all over the world looking for their stake in key mineral and energy deposits.

Chinalco is looking to develop a huge bauxite deposit on Queensland’s Cape York peninsula. British-based BG has made an unsolicited $13 billion bid to get in on the coal-seam-methane business. A Saudi Arabian firm recently engineered the takeover of a small West Australian mineral sands company that makes titanium dioxide (key in the plastics industry).

My point in highlighting just a fraction of the activity that’s going on here every day is simple: this place is a bonanza for investors. There are far more intriguing resource companies than there are analysts to cover them. And remember, the market value of these company’s assets is generally going up (dramatically in some cases). The only other place on earth where you could find more uncovered stocks is probably the Indian Small cap market.

I was not willing to move to India in 2005, mostly because of my bad stomach, ruined by French cheese and room temperature English beer. But Australia seemed like the perfect place to follow the commodity and Asian booms firsthand, and gain a big edge on investors who weren’t here and accepted the conventional analysis of the resource boom. The meat pies are also excellent.

It’s a decision I have not regretted one bit. But let me clarify what I expect from here on out in the resource boom. In a word, I’d say you should look for "epicycles."

There are now cycles within cycles in the resource industry. There are five general categories to keep your eye on: bulk commodities, base metals, energy, agricultural commodities, and precious metals.

Right now, high energy prices are putting huge cost pressures on base metal producers. This, plus the first wave of new supply coming on line last year (especially for zinc, nickel, and cooper) resulted in a cooling off in base metal price last year. Meanwhile energy stocks took off, along with agricultural commodities.

My forecast is that high energy prices are about to knock everybody back a peg or two and result in reduced demand for energy for the rest of this year. Supply will remain tight in oil markets. But consumers (industrial and commercial) will roll back demand. Oil traders will take profits and we’ll probably see oil somewhere around $105 before the end of the year (barring geopolitical events).

Meanwhile, bulk commodities have already seen big year-over-year increases. Coking coal prices tripled earlier this year while thermal coal prices were up 75%. The iron ore price gain of 85% certainly won’t hurt Rio’s earnings either.

Ironically, many Aussie coal producers will make more money on lower production volumes this year. Bottlenecks with rail and port infrastructure on Australia’s East Coast mean that producers can’t fully take advantage of the big price gains this year.

This infrastructure problem itself is actually a great investment opportunity too. Not only are Australia’s top engineering and infrastructure firms making a killing on the local boom, they’re active in South East Asia, the Middle East, and Africa. For the coal producers – if they are not swallowed up by Xstrata first – earnings won’t start to benefit until the second half of this year or early 2009 (although stock prices have already begun to reflect the higher coal prices).

I would not be a seller of energy stocks at this time. However, it looks to me and my team of analysts here like base metals are due to take over the leadership in commodities for the rest of the year. Ag and energy may cool. Most of the bulk commodity prices are still negotiated, although there is a move afoot to base coal and iron ore prices on an index. This reflects the added liquidity in the markets: there are a lot more buyers and, increasingly, a lot more sellers.

It’s the new sellers we’re interested in the most in our Aussie research. You could do a lot worse than own BHP, Rio, and Woodside, and Worley Parsons for the next twenty years. BHP alone is like a mutual fund of commodities.

But the big earnings growth and the massive revaluation of ore bodies is taking place with the smaller and newer producers too. And this is where I believe it’s actually to your advantage that there are so few analysts covering smaller Aussie stocks. In fact, as one mining executive I spoke with recently said, "Even the analysts that are covering us don’t know how to value us. They are all using discounted cash flow models and don’t know much about geology or commodities."

In ignorance, there is opportunity!

Australia has an abundance of scarce resources. It’s a bit of a paradox. But then, the platypus is an animal native to Australia. That duck-billed, beaver-tailed, venom shooting, egg-laying marvel has DNA from both reptiles AND mammals. It’s one of a kind, just like the Australian economy, which has not suffered a recession in 17 years.

Regards,

Dan Denning
for The Daily Reckoning
June 25, 2008

P.S. Australia remains perfectly positioned to be a key resource provider of the developing world’s industrial boom, as long as that boom shall last. It will be much longer than you think.

Dan Denning is the editor of The Daily Reckoning Australia. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected "big-picture" investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.

The most boneheaded miscalculation of all time…

"Terrorism will be reduced…weapons of mass murder will be limited, people will be safer around the world, human rights and democracy will be unleashed in the Middle East, and the fragile outlook for world prosperity will be improved… The uncertainty tax on world growth will be lowered too, as will the energy tax from temporarily spiking oil prices."

This was Larry Kudlow writing in March, 2003.

The spike in oil prices he described took place on March 12th, 2003, pushing the price of a barrel of crude all the way up to $37.83 and the price of a gallon of gasoline to $1.72. Yesterday, oil closed at $137 and gas sells for $4.06.

But Kudlow was hardly alone in his hallucinations. Laurence Lindsey, then George Bush’s senior economic advisor, looked into his own crystal ball and saw nothing he didn’t like.

"Under every plausible scenario, the negative effect will be quite small relative to the economic benefits… The key issue is oil, and a regime change in Iraq would facilitate an increase in world oil," thereby driving down oil prices.

Paul Wolfowitz, then Deputy Secretary of Defense, went on to reassure the nation that Iraqi oil revenues would pay all the costs of reconstructing the country.

Today, we are talking about one of the most boneheaded miscalculations of all time. Almost with a single maladroit stroke, a relatively small group of world-improvers undermined the progress of 9 generations. Five years later, Americans are on the losing end of the "biggest transfer of wealth in history," as T. Boone Pickens described the oil market of 2008. George W. Bush has the highest disapproval ratings of any U.S. president in history. America’s most profitable industry – finance – has collapsed…its currency has lost a third of its value…and European, Chinese and Indian economists are wagging their fingers saying, "I told you so."

But here at The Daily Reckoning we always look on the bright side. And the sunny side of this story is that the United States needed to be humbled. After the Soviet Union fell to its knees in 1990, America had a monopoly on worldwide military force. Nature abhors a monopoly; she needed to take the U.S. down a peg. Who better to do the job than this group of neo-cons? They knew no history; nor did they understand economics. They were the perfect people to lead the nation to disgrace and bankruptcy.

Mr. Kudlow continued his miscalculation by referring to a survey, in which 69% of respondents said they would gladly pay $300 for the war.

So far this year alone, the price of crude has risen 40%. It’s now $100 higher than when the neo-cons took America into the Iraq War. Each American uses 25 barrels of oil per year. This is equivalent to a tax of $2,500 in additional energy expense per person…or $10,000 for a family of four, annually. In addition, the war itself is estimated to cost between $1 trillion and $2 trillion. Divide that by the number of U.S. families and you get a figure of $10,000 or more.

Ooops.

But the numbers are just the beginning. High energy prices are undermining the American way of life itself, such as it is. As colleague Byron King explains, below, we’ve spent the last 100 years building the wrong kind of world. Now, many Americans are doomed to live in the ruins of a civilization that no longer works.

"Rethinking the country life," begins an article in the New York Times. "Suddenly the economics of American suburban life are under assault," it continues. Then, it gets down to business.

When Larry Kudlow, Laurence Lindsey and Paul Wolfowitz were explaining how nice it would be to rough up the Middle East, the average suburban American household spent $1,422 on gasoline. Now, according to the Bureau of Labor Statistics, the sum has risen to $3,196. Another estimate puts the increase in energy costs to the typical family at $50 per month. Anyway you look at it, it’s a lot of money for people who don’t have much money. And the figure goes up the further you get out in the boonies.

"Life on the edges of suburbia is beginning to feel untenable," says the Times.

Like it or not, Americans are being forced to park their cars. This spring, they cut back on their driving at a sharper pace than anytime since 1942. But it’s hard to stop driving when you live far from work and far from shops.

Meanwhile, we got the latest figures on the U.S. housing market. According to the Case/Shiller survey, prices fell at their fastest rate ever in April, down 15.3% over the year before. This no doubt contributed to an enveloping funk in consumer confidence, which hit a 16-year low.

The confidence level of suburbanites falls with their house prices. We have no proof, but our guess is that no houses are falling more than those built most recently, most far out. That’s where homeowner equity is likely to be lowest…and where the increased price of commuting hits hardest. That is where house prices ought to be most vulnerable. Potential buyers will simply add up the costs of commuting – in time and money – and subtract it from what they are willing to pay for the house. The longer the commute, the lower the price.

"Prices in outer suburbs will get clobbered," concludes economist Mark Zandi.

The country will be turned inside out by higher energy prices. The suburbs are becoming less and less desirable…compared to concentrated, close-in developments near city centers. For the first time since the 1920s, the inner cities are ‘in.’ The suburbs, meanwhile, are ‘out.’ And the further out you go…the further ‘out’ they are. Over time, many of these out-lying suburbs are likely to become slums…or maybe simply abandoned, left to become ghost towns, with tumbleweeds blowing through the empty split-levels and burned-out neo-colonials.

In the fashionable inner cities, meanwhile, the middle classes will adapt and probably be better off for it. They’ll walk to restaurants, to school, and to shops. In the far out suburbs, consumers will regret every trip to the shopping mall…and rue the day they listened to Larry Kudlow.

But here we let Byron King pick up this point…

"The returns are coming in from the distant precincts of the oil patch, and the winner is… Oil!

"The price for oil has barely budged based on the Saudi Summit. There has been no summer sell-off, and I’d be surprised to see a significant pullback as the summer driving season kicks into gear. (Followed by hurricane season, and then the buildup for winter heating stocks, followed by winter.)

"What’s going on? Well, what the Saudis give – in proposed, future increased production…the Nigerians take away – with ongoing oil patch carnage that forces the likes of Shell and Chevron to close vast pipeline systems. Apparently the present trumps the future, even in the futures markets. Everything is connected to everything else, isn’t it?

"Here is my take on the exit polls from the Saudi Summit…

"Consumers and their representative governments are desperate for an oil pullback. This $135 oil is draining budgets. The poor and working poor are already marginalized in this cruel world of ours. Now it’s the turn of the middle classes to get kicked into the cellar of the modern age. People are working time-and-a-half just to put food on the table and gas in the car. Retirees and others on more-or-less ‘fixed’ incomes are impoverishing slowly. Unless they are impoverishing fast. Bankruptcy filings among the older and elderly demographics in the U.S. are soaring. The bottom line is that the conventional image of a ‘decent standard of living’ is rapidly receding for many tens of millions of households. The 20th Century is truly over. (I think this has much to do with the meteoric rise of Senator Obama as well… He offers nothing new – mostly just classic, populist Democratic Party bromides – but he offers it in such a sweet and beguiling, Teflon-coated manner…)

"And it will get worse before it gets better. To be perfectly blunt, it might not even get better. Over the next year, and into the foreseeable future, in the developed world people will go broke buying motor-fuel, heating oil and natural gas. (Wait until next winter… Sweet Jeeeezus!) In the less-developed world, people will go broke buying bread. And then the poorest amongst us will starve. Any way you look at it, it’s bad for business.

"Fast-rising energy prices are decapitalizing entire nations. Energy prices are destroying wealth faster than people can re-create it. Entire segments of the world economy have hit the iceberg and are filling with cold seawater. Some industries are becoming obsolete in a matter of months. Much of the airline industry is drowning in red ink before our eyes – almost every flight in the sky is losing money, no matter how much they charge to check your suitcase or how few peanuts they put in the small package.

"And down on the ground, most motor transport is just plain uneconomic any more… ‘Dead Rigs Driving.’ Farewell to the ‘Warehouse on Wheels.’ Sic Semper Globalization.

"Large swaths of the auto & truck building industry have become capital-wastelands. For example, GM is closing SUV factories and planning to ditch the Hummer brand. This cascades down to firms that make everything that goes into a set of gas-guzzling wheels. You name it: hot-coiled strip, axles & tires, wire bundles, paints & coatings, window glass and seatbelts, and so much more. Billions of dollars worth of past investment is just gone…bye-bye, poof! And the good-jobs-at-good-wages? History.

"So, is there room for optimism here? Yes, in the sense that high prices are concentrating many minds on energy. ‘Energy’ is the most important issue of our time, bar none. That is, people are finally beginning to understand the centrality of energy to our collective existence. Take away the cheap energy, and it becomes clear that mankind has spent the past century building the wrong kind of world.

"Another way of saying it is that we’ve collectively built ‘tomorrow’s ruins’ today. And I don’t mean just the physical structures, the bad architecture and stranded infrastructure that is worthless when energy is expensive. Think as well about the social structures that are beyond worthless when energy gets expensive. Tell me when you start to get worried…

"Much of what happens in our time only happens because energy is relatively cheap and abundant. So when energy gets expensive, a lot of what happens is going to stop happening.

"I leave the rest to your imagination."

Until tomorrow,

Bill Bonner
The Daily Reckoning

Go East, America! Go East! originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The Fed is not literally printing new money to lend to Wall Street banks. What it IS doing is trading its stock of healthy (if you can call them that) U.S. Treasury bonds, bills, and notes for illiquid, not healthy at all, mortgage backed bonds. Fed-followers argue the Fed can actually make money on this deal by demanding a large discount on the collateral and charging borrowers a hefty fee for the temporary asset exchange. Blah blah blah.

The Fed’s current collateral-laundering policy is clearly inflationary. While not directly increasing the liabilities of the U.S. government (yet) the Fed only has about $700 billion in Treasury’s it can lend out for 28-days at a time (or longer, if it sees fit.) The promise to lend up to US$200 billion as of March 27 eats into this US$700 billion. And that leads us to what comes next.

First, the Fed [yesterday] lowered the discount rate on direct loans to commercial banks from 3.50% to 3.25%. It also, as we expected, extended the terms of this emergency loans (collateral swaps) from 30 days to 90 days.

Next, according to the Fed’s release, "the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets."

"This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York."

The Fed said the cut in the discount rate and the new lending facility are "designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth." Yes, they are.

But will the Fed’s surprise Sunday double-barreled policy action turn the tide for stocks?

If not, there is always the Fed funds rate to cut [today]. The Fed will almost surely lower short-term rates again this week from 3% to something like 2.5% or even 2.25%. Keep in mind this puts real U.S. interest rates below the rate of inflation. Negative real rates are obviously inflationary.

But here’s the other thing. If the current liquidity crisis spreads beyond Bear Stearns, the Fed will be compelled to make all of its US$700 billion in Treasury assets exchangeable to distressed firms. It has said as much in accepting a "broad range of collateral" it is willing to accept in exchange for short-term funds. Once the Fed depletes or exhausts its inventory of Treasuries it can swap for illiquid assets, what does it do?

It has to go out and buy more Treasuries on the open market. And to do that it WILL need to create new cash, which is definitely inflationary. The Fed hasn’t yet monetized bad mortgage debt by creating new cash to buy it from banks. Instead, it’s trading good debt for bad debt.

We reckon – the way this thing is playing out – that the Fed is going to have print more money soon. It will either print more money to buy more Treasuries to lend to illiquid, poorly capitalized financial institutions (Fannie Mae and Freddie Mac come to mind).

Or, if things really get desperate, the Fed will have to create new cash to directly purchase impaired assets from financial institutions. This is why it’s called "monetizing debt" by the way. The central banks turn liabilities into cash by printing new money to buy the debt from its current owners.

This kind of deal bails out the owners of the bad debt (the investment banks and mortgage lenders). It keeps the financial system alive. It prevents the further sale of assets and the loss of depositor’s money. And it prevents a complete collapse of confidence in the financial sector, as happened in the Great Depression. But it does it all at a great cost: the viability of the U.S. dollar as the world’s reserve currency.

So, the Fed’s liquidity efforts will become truly inflationary when it runs out of Treasury bonds to exchange for dodgy mortgage collateral. There is an interesting argument to be had over whether the new dodgy collateral becomes the backing for the U.S. dollar. But we will leave that aside. We wonder today how many bullets the Fed has left in its monetary policy gun.

"The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with yesterday’s decision to become a lender of last resort for the biggest Wall Street dealers," reports Scott Lanman at Bloomberg.

It also cut the discount rate this weekend, he ads. "The action comes on top of Chairman Ben S. Bernanke’s other balance-sheet commitments totaling as much as $430 billion through other auctions, repurchase agreements and $30 billion in financing to help JPMorgan Chase & Co. purchase Bear Stearns Cos."

The Fed can throw another grenade into markets when it meets [today]. If it acts true to its recent form, you can expect to see the Fed funds rate slashed by a full one percent. Pretty soon Bernanke is going to run out of bullets. He’ll have to throw the gun!

Here’s the question though, how does any of these help Americans pay their mortgage? Does it? Making inter-bank credit cheaper isn’t even encouraging banks to lend to one another. The Fed has had to step in and become a direct lender to prime brokers.

Air Marshall Bernanke is in trouble. As soon as he runs out of his stock of Treasury bonds to lend to distressed banks, he’s going to have to buy more. He’ll have to create new money to do it. And if he somehow escapes that necessity, he may have to purchase outright the collateral held by Fannie Mae and Freddie Mac. That will take new money too.

It is probably Henry Paulson’s turn to do something to save the system, although we are not sure what. Paulson opposes a bailout of investment banks. But maybe he won’t be as opposed to the creation of a new authority set up to purchase the assets of Fannie Mae and Freddie Mac and hold them in trust. Then, millions of Americans will have Uncle Sam as their landlord (overlord).

Regards,

Dan Denning
for The Daily Reckoning
March 18, 2008

Dan Denning is the editor of The Daily Reckoning Australia. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected "big-picture" investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.

That was the bad news borne by Bear.

"Scramble to calm markets," is today’s frontpage headline on the Financial Times. Yesterday, the Dow went up…the Dow went down…and the Dow ended almost where it started the day.

Gold went down $3. Oil fell $4.53. And commodities got hit hard; the CRB fell 23 points.

And the dollar took another beating too. It sank to a 12-year low against the yen (JPY). Against the euro (EUR), it dropped to $1.56.

"We have entered a new, scarier, uglier phase of the crisis," said Marco Annunciata of UniCredit.

A major failure on Wall Street usually means the end of a market downturn, says John Authers in the FT: Continental Illinois in ‘64, Drexel Burnham Lambert in ‘90, Kidder Peabody in ‘94 and Longterm Capital Management in ‘98.

But was Bear the end of the problem…or just the beginning?

"Wall Street waits for the next domino to fall," says an FT headline from yesterday.

In the aftermath of the Bear saga, investors started asking questions about Lehmann Bros (NYSE:LEH). The firm had to publicly announce that it was solid. Of course, Bear said it was solid too. And as Walter Bagehot remarked in 1873, "every banker knows that if he has to prove he is worthy of credit…in fact, his credit is gone."

Soon, other Wall Street institutions are going to begin announcing their latest results. The tide has gone out; we’re going to see who’s been swimming naked, says Buffett. One thing we’re going to see is huge leveraged loan portfolios written down. Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) are expected to write off about $1 billion. Deutschebank says the writedowns will be about $9 billion over the next 6 months. DB itself has more than $50 billion of leveraged loans (to private equity) on its books. Goldman has nearly $40.

But not to worry, U.S. Treasury Secretary Henry Paulson says, "our financial institutions are strong" and that he will do "whatever is necessary" to keep the system working properly. The president of the all the Americans, George W. Bush, too, has said that while the times are "challenging," he and his team are "on top of the situation," which is what we were worried about. Meanwhile, the papers say that Ben Bernanke is being pressured to cut rates…and the bookies are giving long odds that he won’t.

We will worry anyway, thank you. Because we doubt that the science of central banking as practiced by Bernanke, King and Trichet is really any more reliable than the science of modern portfolio management as practiced by the geniuses at Bear, Lehmann and all the others. (More on that later in the week…)

But let us step back and look again at the big picture.

We take as a given that central planners are as prone to error as a bear to honey. It also seems likely to us that it was a mistake for Alan Greenspan to cut rates so aggressively in ‘02-’03 and leave them below the inflation rate for so long. The result was an orgy of spending and borrowing in the Anglo-Saxon economies…and an orgy of factory-building and capital formation in Asia. In both parts of the world, people missed their marks – overdoing it considerably.

And now there is Hell to pay.

As to how the bill will be settled, we are uncertain. There are two schools of thought.

On one hand are the deflationists, who see an economic meltdown, with lower prices…and a flight into U.S. Treasury bonds (and the dollar) for safety.

Below…we present a lively exchange between the two schools of thought. But here at The Daily Reckoning, we never liked schools. We played hooky at every opportunity…and learned what we could by keeping our eyes open. In fact, now we see a different world than either the inflationists or the deflationists…a world both rising prices…and falling prices…where inflation and deflation alternately bicker and make up…like a married couple.

We have described this tension as a "war" between the two forces – one, unstoppable…the other, irresistible. But the two are as likely to be friends as enemies. They may squabble and even come to blows…but they still sit down to tea with each other at 4PM. They can’t live with each other…and can’t live without each other.

Yesterday, for example, we saw them both walking along, holding hands. Stocks rose in the United States. But so did gold. And when they visited the treasury market, bond prices rose sharply as yields fell.

And then they paid a visit to the commodities markets and took prices down a peg. The dollar, too, they brought down.

In the months ahead, who knows? The two could fall out completely. If that happened, there could be a meltdown in the few things that are going up – commodities, treasuries, oil and even gold. Or there could be a meltup in the things that are going down – stocks and property.

We don’t know. As a financial analyst, this uncertainty worries us a bit. But as a moral philosopher, we take it for granted that there is more under heaven and earth than is contained in our philosophy. We’ll let Mr. Market tell his tale…and happily listen.

*** But let’s look at how our Trade of the Decade is going. With only two more years to go…not bad! Gold was about $260 at the beginning of the decade. It’s now nearly 4 times that number.

Stocks, as measured by the Dow, are only a bit below their peak set in 2000. But U.S. stocks generally are "officially" in a bear market, having lost 20% of their value from the peak. And measured in gold, stocks are down 72%. It took 43 ounces of gold to buy the Dow in early 2000. Now, it takes fewer than 12. Let’s see what the next 21 months bring.

And if you’ve been wary about getting in on our Trade of the Decade, we have a unique opportunity for you. You can get gold out of the ground and into your portfolio – for a penny per ounce. No joke…and no shovel required.

*** Our new friend, David Fuller of FullerMoney.com wonders whether this isn’t the time to do a little contrarian buying.

"In a contrarian play, I also think a bombed out bank such as UBS is interesting. Today, it has an estimated PER of 8.44, although I suspect earnings forecasts are too optimistic. However UBS also has a dividend of 7.58% which is covered 2.67 times according to Bloomberg. Perhaps there will be more shocks in the form of writedowns; perhaps more SWF support is required; I would not rule out a rights issue at some point."

*** A milestone was reached last week. France’s last WWI veteran, Lazare Ponticelli, died at 110 years old. R.I.P. The Great War was probably the single most important event of the 20th century. It brought an end to bourgeois civilization. After it was over, Europe couldn’t return to the forward-looking bourgeois civilization it had before the war. Its art changed. Its architecture changed. Its manners. Its government. Its money.

And America changed too. The United States has tasted the fruit of empire. At first, she didn’t care for it. Woodrow Wilson got sick on it and never recovered. But gradually, then suddenly…after Japanese planes attacked Pearl Harbor 20 years later…she gave in to it…made a habit of it…and grew to like it.

*** Here is a message from a Dear Reader from Australia who makes the case for deflation. (His first comment is about the Fed’s latest bailout):

"I think Bill Bonner has the wrong end of the stick. The Fed is not pumping in anything – it is an asset swap with the banks and other financial institutions whereby the Fed takes the unwanted mortgage backed securities (at a suitable discount) in return for lending its own high quality Treasury notes. These will then be negotiable as collateral to raise money. It is a neat trick to liquefy the debt market but in the process the Fed is taking on the risk that other banks do not want to accept. It will hope that the discount to valuation will cover the failures. In time it may even profit. The question is this – since this is a term lending facility, will the Fed in managing its credit risk ever pull the trigger on a major bank and demand re-payment? Are we witnessing a de facto nationalization of the U.S. banks?

"The point is that what the Fed is doing now is not inflationary – the money supply and cash in circulation has actually been falling. See James Hamilton’s (Professor of Economics at the University of California) explanation.

And as for buying gold:

"[The] view that gold will see a substantial re-valuation is correct but it may take a detour back to $400 or lower – simply because in the deflation to come, which will be brought on by an escalation of the current liquidity crisis, gold will be sold off to pay for margin calls. Gold will be re-valued in the future because it will most likely come back into service again as the standard against which all currencies will be measured. This accelerating crisis has been brought on by banks by-passing the prudential requirements through securitization of mortgages and by the use of massive leverage on the part of borrowers to magnify the gains made from the consequent asset inflation. Credit creation (money supply) has been on a tear for a decade or more because banks were able to keep the loans off their balance sheets through securitization. This process is now in the early stages of reversal.

"Most of what we read about in the financial columns today was brilliantly explained by Robert Prechter (of Elliottwave International) in his best seller of 2003 Conquer the Crash. As far as the equity markets are concerned, he was wrong in nominal terms because they continued to rise until last October. In terms of gold, the Dow, S&P500 and NASDAQ have all been falling since 1999. His explanation then of the likely unfolding of events is closer to what is happening right now than any other commentator present or past. Inflation is NOT the issue. The markets know it (why else would US bonds and Treasury notes be in such demand) and the Fed (as always) is following the 3 month US treasury bill down the lowering yield path. I believe that the US Treasury market is telling the real story."

Dan Denning offers a rebuttal in today’s guest essay, below. Keep reading…

Until tomorrow,

Bill Bonner
The Daily Reckoning

Bernanke is Going to Run out of Bullets originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The last days of the American Empire are playing out with quite a bit of drama. We say last days, but really America’s decline could be long and slow like Japan’s, but punctuated with periods of intense volatility and instability.

All 30 Dow Jones Industrials stocks fell. The Dow index closed down 370 points, or 2.9%. The bad days were supposed to be over in January. Yet yesterday was worse than any single day in January. The culprit?

The Institute of Supply Management reported that its non-manufacturing index fell to 41.9 from 54.4. What does that mean? A reading below 50 means the service industry is in contraction. We went from modest expansion to not so modest contraction. There is a word for that. That word is recession.

You didn’t really need any mundane economic indicator to tell you that though, did you? Home prices in the United States are falling. Foreclosures are rising. Losses in the financial sector are substantial and ongoing. It’s no wonder the S&P 500 is off to its worst start in 80 years, according to analyst Howard Silverblatt. The benchmark index of U.S. multinationals is down 8% to begin the year.

Where does this American fascination with economic data come from? Our late mentor Dr. Kurt Richebacher was highly critical of American economists (most of them) for being ignorant of theory and addicted to economic data. The addiction to data comes from the belief that the economy is a machine which can be operated smoothly and efficiently, provided you get accurate readings from all your dials, meters, bells and whistles.

Ironically, this reduction of a complex economy to a massive pile of spreadsheets and economic data has its roots in an obscure group of German economists called the Historicists. Dr. Kurt would be embarrassed. The most forceful advocate for the Historicists was Gustav von Schmoller. What did the Historicists believe?

The Historicists didn’t believe in general, universal economic laws. They criticized classical economists like Adam Smith and David Ricardo for making broad statements about human behavior and the nature of markets. Economics, they said, was not an exercise in deductive reason, where you could start with a general principle (each man always acts in his own self interest) and then analyze particulars.

Nope. The Historicists claimed economies had to be analyzed on a nation-by-nation basis, with emphasis on the different circumstances in each place at each particular time in history. It was inductive and empirical, which led, we reckon, to the habit of accumulating massive amounts of data and sifting through it to find patterns and trends that could, a) tell you what happened and, b) what might happen next.

Today, of course, we have massive amounts of economic data and willful ignorance of the basic axioms of wealth. You cannot measure some of the most important things in life. How much utility does a wheel of cheese have? How badly can a heart be broken? What is the price of a happy marriage? Not all of human behaviour can be reduced to a number or a price.

And there are some general axioms worth remembering that seem to always be true in all places at all times. You cannot get rich by spending more than save. Nations don’t become powerful consuming more than they produce. Debt is not wealth. War is not peace. Freedom is not slavery. And ignorance is not strength.

Besides, who really cares about the economic data a month-to-month basis? We’ve known for years that debt-based wealth-whether in the UK, the US, or Australia-is the road to ruin. Some people are just now finding out how far along that road we are. We’re very far indeed.

Regards,

Dan Denning
for The Daily Reckoning
February 06, 2008

Dan Denning is the editor of The Daily Reckoning Australia. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected "big-picture" investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.

Big drop in the Dow yesterday…down 370 points. Gold fell hard too…minus $19.10 – to $890.

Everything falling…sinking….declining…dying downwards – deflation…deflation…deflation…

What is happening?

We explained yesterday that the great boom of the last quarter century was a bust for Americans. And we explained why:

1. Because Americans made a critical mistake – misled by their own financial authorities…by the reckless saving of Asians (in dollars!)…and by their own misguided belief in capitalism. Result: they spent too much, borrowed too much, and saved too little.

2. Because Asians (and other foreigners) entered the world economy. Aided by modern communications and government policies designed to encourage globalized commerce, this huge new supply of cheap labor lowered wage rates in the United States.

But we did not mention a key point. Americans misunderstood the nature of capitalism itself. It is not an "economic system" that makes people automatically richer. It is a moral system…a system that rewards virtue and punishes error. You don’t get richer because of Free Enterprise. Indeed, as the economic history of the last quarter century shows, you can get poorer. The market system merely provides the setting in which you get what you deserve. You could get rich – if you were to do the right thing: work hard, save your money, innovate, take chances, forgo consumption. But do the wrong thing…and you will pay for it.

We received this note from a Dear Reader today:

"My sister and her husband were the ideal success stories. She is in management at the state utility, my brother in law was an engineer at the local nuclear power plant and later got his law degree at about age 46; working and studying simultaneously, commuting out of state, resulting in an early heart attack due to stress and smoking.

"They had a beautiful 3,000 sq ft home with a pool, built in cherry wood finishes and top- of-the-line vehicles. After they sold their home to move to an ocean view, 1 bedroom property (that they gutted down to nothing and put in over $150,000), they realized that they owed more than the current house was worth.

"Here are two professionals with advanced degrees, one in business, the other in engineering and law working and studying all their lives with nothing to show for it. They now owe more than what they have is worth. My sister is sadly saying that now she won’t be able to retire. She is 55 years old, has worked hard getting up at 5am every morning, traveling one hour to her job. Traveling for the utility, working almost every weekend, taking extra courses, years and years of work and she has…nothing…absolutely nothing."

That is why trying to keep the party going is such a huge mistake. Why encourage people do to the wrong thing? Why keep the bar open any longer? Providing more money…and more credit…and bigger government deficits only creates more drunks. It merely compounds the error, with more people fumbling for their car keys when the party is finally over. What good could possibly come from more consumer spending now? More credit card debt? Bigger houses…bigger mortgages…more new houses available for sale? Higher house prices? Higher stock prices?

Americans are already living beyond their means. What is the point of more stimulus? What could it stimulate them to do, but live even further beyond their means?

"Bill, you just don’t understand the wonders of modern macro-economics," comes the response. "The authorities are simply doing what they should be doing; they’re putting more spending power into the economy to offset what appears to be a cyclical downturn. That way, they’ll be able to prevent a more serious slump. We don’t want to fall into a Japanese style trap, do we?"

Apparently the feds are geniuses. They’ve figured out how to harness capitalism…how to take out the downside…how to eliminate mistakes. They think they’ve taken Mr. Market off the mean streets and out of the wild slums. They think they have him behind bars…they think he’ll do what he is told. Now, thanks to their adroit management, we no longer have to worry about slumps, crashes or recessions. If Americans spend too much…no worries…the feds will just give them more and more cash and credit, forever and ever, amen.

Mr. Market can be an agreeable fellow. He’ll go along with a good gag…for a while. But he eventually gets tired of it. Eventually, he finds a way to break out. And it looks like he is now on the loose. And he’s armed.

Yesterday’s big drop in the Dow came as a consequence of a report from the service industry. Sales are falling more than forecast. But what would you expect? Capitalism rewards virtue and punishes error. It was surely an error for Americans (and British…and a few other Anglo-Saxon tribes) to spend so much and save so little. Now, they’re getting whacked for it.

GMAC says it lost $734 million as its home loans "went sour," according to yesterday’s news.

And now comes a front-page story in the International Herald Tribune…

"Reality check: Americans turn thrifty."

This is the story we’ve been following for the last year. Without new money from rising house prices, Americans are stuck. They have no choice. They have to cut back. Not even the checks from a generous Uncle Sam will be enough to offset a housing decline.

The feds may not know which way the wind is blowing, but consumers are beginning to notice the plastic bags in the air. For years, they had the breeze at their backs. Now, it is in their faces. They can’t help but realize that they made a mistake. And they’re beginning to correct it.

Look for consumer spending to fall…and savings to rise.

*** The good and the great…the world’s biggest humbugs and brightest worthies… gathered in Davos, Switzerland last week. Even Bono was there.

They look at the big picture, of course. And they try to think of ways to make the picture a little brighter. But do you think the world is actually improved by a bunch of people drinking champagne and wondering how they can make things better — by meddling with other peoples’ plans? If so, you do not work here at The Daily Reckoning. Our view is different. In our view, the baker does not bake for reasons of altruism or idealism. He bakes to earn his own bread. And as Adam Smith pointed out more than 200 years ago, it is thanks to his efforts to improve his OWN life that the whole world gets better. Or, as Goethe put it: "Let everyone sweep in front of his own door, and the whole world will be clean."

Still you can’t blame the policy makers, the movers, the shakers and the late-night party makers for having a good time… as long as they don’t actually do something.

Water was the big subject at this year’s confab. And here, we give the tip of the hat to Mr. Ban Ki-Moon, UN General Secretary. First, he noted, with no show of humor or awareness, that the response so far to the UN’s initiative on water sustainability had been merely "a drop in the bucket."

Then, he went on to say that he hoped this year’s session at Davos would be as big a success at last year’s, and that "what we did for climate change last year, we want to do for water and development in 2008."

What did Davos do for climate change last year? How did it change the climate? Did all those rich and famous people, flying all those miles in business and first, in those carbon-consuming jet airplanes…staying in those fancy, well-heated alpine hotels…and feasting on delicacies flown in from all parts of the globe – did they do any good for the world’s climate? We doubt it. But we think Mr. Ban Ki-Moon is right. This year’s Davos conference will be an equal success.

Meanwhile, we note that the idea of capitalism – the phony idea that it produces wealth automatically, that is – is alive and well among the world’s elite.

First, a team of researchers asked the ‘elite’ in 18 countries which institution they trusted. They answer: business. Not government. Not the media. Money has upstaged politics, as we pointed out earlier.

Then, Bill Gates – the world’s foremost entrepreneur and richest capitalist – spoke to the group.

"In markets where profits are not possible, recognition is a proxy; where profits are possible recognition is an added incentive," he said.

He was proposing something he called "creative capitalism." How that is different from any other kind of capitalism, we don’t know. In any business, there are different kinds of rewards. Some people like to run art galleries – even at a loss – because they like art. Others want to be in the film industry, because it is glamorous. And who wants to own slum properties and collect rent from drug addicts? Only people who want a high rate of return and don’t care much about prestige or personal safety.

It is discouraging to read accounts of Gates’ speech. The man seems to have spent too much time in front of a computer terminal. He said he wanted to "find a way to make the aspects of capitalism that serve wealthier people serve poorer people too."

Either the world’s number 1 capitalist doesn’t know how much about capitalism. Or he is just another humbugger, like all the rest. He should know that capitalism serves no on in particular. It only serves those who make use of it…those who save…those who invent…those who work and improvise…

It is a moral system, as we mentioned above, serving the thrifty, the quick, the smart… It is indifferent to how rich people are…to their skin color…to the language they speak and to the flag they salute.

Capitalism is always creative…and always destructive too.

*** Our Sunday lunch with the boys was intended to focus on education. Where was Henry going to college? Would Edward like to go to boarding school next year?

Pater Familias laid his cards on the table even before the entrée was served.

"Look, I’m almost 60. I’ve had children around the house for the last 30 years. And for a least a quarter century, my life has been tied to the school schedule; I’m ready for a change."

"Oh…so you want me to go to boarding school, so you can do whatever you want?" Edward saw the point immediately.

"Well, yes…"

"Wait, it’s not just that," Elizabeth entered the conversation. "We’re not sure you’re going to be able to get back into the French school in London. It would be nice to have an alternative."

"A Plan B," said your editor…who suspects that all Plan As are doomed to failure.

"Not only that," the voice of reason returned. "I went to boarding school when I was about your age. I loved it. And I think you’re the sort of person who might like it too. The English boarding schools are very focused on sports and outdoor, team-building activities. Those are the sorts of things you like. Most likely, you’ll go to the French school, but we should look at these boarding schools to see if you like them….and just in case the French school doesn’t work out."

"But I don’t want to go to boarding school," Edward replied. "You didn’t make any of the others go to boarding school. Why should I have to go? It’s not fair."

"No, we’re not going to force you to go to boarding school. But you might want to go."

"I don’t want to…"

"How do you know you don’t want to…you haven’t tried them…"

"Well, I don’t want to try…"

Until tomorrow,

Bill Bonner
The Daily Reckoning

Addicted to Economic Data originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The U.S. housing market isn’t my beat any longer (although if it precipitates a recession in the United States and then the globe, I guess it IS my beat, even from Australia). But I love how history always finds her man, the man to personify all the mistakes and stupidities of financial folly. For the housing bubble, that man is indisputably David Lereah, the chief economist for the National Association of Realtors.

The story of the housing bust would play out just fine without Lereah lifting his voice. The facts are what they are. Over the next 18 months, $2.6 trillion in ARMs will adjust…and many speculators, flippers, and first-time buyers will face rising payments and falling market values. Ouch.

Lereah’s narration to the events just makes the whole thing at least a little comic (and believe me, I know it’s not funny at all to people who are facing foreclosure…I know more than few of them personally and they are almost all asking me what went wrong.) While I try and answer them, I can at least laugh at Lereah.

We learned on Monday that median sales prices on existing homes fell 1.7% in the last twelve months. It was the second largest decline in prices in the 30-years data have been kept and only the sixth recorded year-over-year decline in the last 38 years. We suspect it won’t be the last.

What did Lereah have to say?

“The price correction is a welcome development.”

It is? To whom?

‘The price drop has stopped the bleeding,…sales have hit bottom,” he said. “Sellers are finally getting it.”

Here it pays to be even more suspicious. Back in 1999 at the height of the Internet bubble there were two kinds of investors. Those who “got it” and those who didn’t “get it.” I never got it back then, and I’m not sure I get it now. Lereah is telling us that sellers have recognized that in order to sell their homes they will have to accept a smaller gain, or even a loss?

Lereah says, “I am confident the housing sector is picking up,” He also said that he expects prices to fall for the rest of the year. And here’s where we don’t get it again. He says falling prices will help sales from falling even further.

“If that’s so, we’ll have achieved a soft landing,” Lereah said

Step right up! Get your foreclosed home at bargain prices. Buy it with no-money down and historically low interest rates. We’ll throw in a flat screen TV, a gas-guzzling car, and we’ll cut the price for you.

Wait. That was last year’s show. If falling prices and huge incentives aren’t already drawing buyers into the housing market, what will? The prospect of a quick gains and a flip? That’s history too.

Compelling investment value? Not yet. Maybe after another 20% decline. But even then, we may never see another bubble in housing like the one we watched the last few years. Future housing gains will be the plodding, steady kind that come in the absence of easy credit.

In Shakespeare’s plays the fool is often the wisest character. Under the guise of buffoonery, he is allowed to speak the one thing that people in authority loathe to hear: the truth. But his wisdom is mistaken for wit by those in power, who usually don’t have the wit to understand they are being ridiculed. David Lereah isn’t a fool. He’s a moron. Or, as the Fool says to King Lear in Act One, Scene Four.

Have more than thou showest,

Speak less than thou knowest,

Lend less than thou owest,

Ride more than thou goest.

Editor’s Note: There were probably hundreds of thousands of bad loans written when the sun was shining on this market that will only be exposed once the storm clouds fully gather. This process has only just begun and delinquencies and defaults will cast a pall over the industry. Fixed income investors will flee the subprime lending market in a hurry, fully pricing in the risks of lending where the collateral is overinflated and many borrowers have been less than truthful about income and assets.

History Always Finds Her Man originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.