Our little big bull market celebrated its one-year anniversary yesterday, albeit in tentative style. The Dow managed to eke out an 11-point gain, while the broader S&P 500 fared only slightly better. Investors, it appears, are awaiting the next catalyst to keep the momentum going. But are they running out of excuses to buy?

It is difficult to know precisely what is going on inside the collective brain of the marketplace, but one indicator gives us a hint. The VIX Index, also known as Wall Street’s “Fear Gauge,” measures the implied volatility over the coming thirty days. A high reading represents costlier options, commonly used to hedge against any sudden down trend. A low reading indicates a lower hedging cost, meaning that traders expect relatively calm waters ahead. At its extremes, the VIX Index is a rather useful tool for contrarians. When the VIX breaches its moving averages to the upside, it’s usually a pretty good sign that the market is oversold. Conversely, when the index dips below certain key points, it’s probably a good time to expect the unexpected, so to speak.

Right now, the VIX is bobbing around close to its 18-month lows. That means traders are not forecasting much of anything…a pretty good sign that we’ll see quite a bit of something. Last Friday, the measure fell to 17.5, a level not seen since January…when the S&P promptly fell from around 1,150 to 1,050. Before that, the VIX had not seen a reading of 18 since August of 2008…right before the market went skydiving without a parachute. By March of 2009, a few short and painful months later, indexes around the world had almost managed to saw themselves in half…and worse.

Just before the global financial collapse, your editor took advantage of the rampant overconfidence in the market to implement a little preemptive “austerity plan” of his own. And so, from the gaudy bubble-central of Dubai we took the long road east, making sure to pass through notably inexpensive destinations like India, Nepal and Southeast Asia. Without a country full of union workers to protest the move, this was relatively easy to do (sorry Greece…and France…and Britain…and, well, Europe). Here in the Far East, we can enjoy the same or better lifestyle for a fraction of the price. Rent is less than half what it was in Dubai. Food costs next to nothing. And, as an added bonus, your editor’s girlfriend is not obliged to dress like a ninja when we take weekend trips to neighboring countries…not even when we visit Japan.

One would need a degree in modern economic theory not to see the problems lurking below the surface of this market rally. That or a job in a government office…in which case you’re paid not to notice. But the fortunately untrained eye can’t help but notice the worsening unemployment situation, a deteriorating real estate market – especially in the commercial sector – and a public balance sheet that looks even worse than the private one that led us all into this mess in the first place.

While on our little pilgrimage of austerity – back at the end of ’08 – early ’09 – we ran into dozens of ex-bankers and newly redundant financial services workers. We found them lazing on the beaches of Viet Nam and sipping $2 daiquiris at the bars around Bangkok. A few of them had plans for the future, but mostly they were there to somehow, vaguely, “ride it out.”

Our little big bull market may be a year old but, if we had to bet, we’d say it’s a rally in overconfidence only, as presently exhibited by the VIX index. On the bright side, the bar staff at the resorts in Phuket can look forward to another influx of lost souls armed with loose severance packages.

Joel Bowman
for The Daily Reckoning

Deciphering the VIX Index and the Rally in Overconfidence originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

Then, almost as quickly as it had begun, the party ended. Black Tuesday, October 1929, was somewhat akin to calling “closing time” at the Gatsby mansion cocktail party. Markets crashed, the public panicked and central planners did everything in their power to exacerbate the situation they themselves had caused in the first place.

The decade that ensued was perhaps best captured, observed Chris, in John Steinbeck’s memorable Grapes of Wrath. The parched plains…“Oakie” drifters…the all-too common hardships of the farm folk… We all remember the scenes as if we had lived through those heartbreaking years ourselves. A bit of a Steinbeck enthusiast himself, your editor has spent a good while mulling over Chris’ astute comparison. The imagery contained in those two momentous works, both Steinbeck’s and Fitzgerald’s, are so vivid that the reader almost feels he can touch the characters, taste the champagne and, eventually, feel the anguish and despair of the stricken Joads.

If you didn’t guess it earlier, the point Chris was making was simply that history tends to repeat itself. The Gatsby years, for instance, might not have been so different from those of the late 1990s – early ’00s; a period of excesses, frivolity and of “irrational exuberance” as Greenspan, the man largely responsible for causing it, noted (though he did so before it had actually materialized, in a typically ill-timed speech delivered back in 1996…before the market more than doubled over the ensuing four years. Oy…). And now, with our own depression unfolding, central governments around the world move to centralize power, to clamp down on free economies and to limit the corrective forces of the marketplace…thereby virtually assuring we will enter another Steinbeck-esque stage, if we haven’t already done so.

As we look around the world today, we wonder if we can’t draw a few more parallels between the early to mid-20th century and the time in which we now find ourselves. And, perhaps hidden within these folds of time, we might discover some clues as to where we are headed in the not-so-distant future. If we’re moving towards a Grapes of Wrath-like scenario, in other words, what comes afterwards?

While Gatsby’s crowd was swinging to the smooth sounds of the roaring twenties in the USA, another man was wallowing away in a dank cell on the other side of the world. Having failed in his attempted November revolution in Munich (1923), the “political prisoner” (as he called himself), set to work dictating his life’s philosophy. The Weimer Republic, still recovering from the nation’s disastrous expeditions abroad during the previous decade, had just suffered through one of the most infamous hyperinflationary spirals in history. It wasn’t until then foreign minister, Gustav Stresemann, issued a new currency, the Rentenmark, that his republic began what is now referred to as the “Golden Era” (1923 and 1929). But even during this period, unemployment grew in step with the republic’s mounting foreign debts and discontent among the working class brewed. If ever a megalomaniacal dictator was to sway the masses, now was the time to make his stand.

Although it was published in two parts during the twenties, the prisoner’s work didn’t garner any real, widespread attention until its author ascended to power in 1933. That man, of course, was Adolf Hitler. His book: Mein Kampf. During the Führer’s reign of terror, his book came to be available in three common editions. First, there was the Volksausgabe or “People’s Edition.” This was the most commonly circulated. Then came the Hochzeitsausgabe, or “Wedding Edition” which was given free to marrying couples. And finally, in 1940, the Tornister-Ausgabe was released; a compact, though unabridged edition which was available at post offices, where it could be sent to Nazi family members fighting on the front lines. Tragically for many a sorry soul, the 1940s were to be defined by the work of one of the century’s most infamous authors, Adolf Hitler.

That decade, as everyone knows, was more or less an unmitigated disaster for most of the world. From the islands of Japan to the bloodied desert sands of Northern Africa…the streets of Paris to the burning gates of Stalingrad, the devastation seemed unrelenting. Track marks from Russian T-34s, German Panzers and American M4 Sherman tanks crisscrossed Europe from end to sodden end. And, in the midst of it all, a brave little girl, hidden away in a secret annex with her family in The Netherlands, sat down to pen her own prisoner’s memoir.

Fast-forward to today and we find ourselves in a situation eerily similar to that of the early ’30s. Tensions in Europe are once again heating up over the possible collapse of its relatively nascent monetary union experiment. Nations there have, as they are wont to do, overspent their kitty. This time it is Greece, Italy, Ireland, Portugal and Spain, whose balance sheets are coming apart at the seams, that threaten to drag the financial credibility of the whole continent asunder. Workers in Greece are on strike over austerity measures their government has undertaken to try to manage its budget. Disgruntled protestors numbering in the tens of thousands marched through the streets of Athens this week.

Elsewhere on the continent, air traffic controllers in France are off the job…as are thousands of British Airways workers over in the United Kingdom. Another 70,000 discontents thronged the squares of Madrid…and 50,000 in Barcelona. Workers in Ireland and Portugal are itching to join the queue. And that’s just the kerfuffle in Europe!

Regards,

Joel Bowman
for The Daily Reckoning

Seeds of War originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

What do these single day data points tell us? On their own, probably not much. Put together…still not much. Stick your nose close enough to the computer screen and pretty soon the daily numbers begin to lose their meaning. Journalists report only after the facts, making up their reasons for this and that move as they go.

“Investors shrug off concerns about XYZ, display confidence in recovery,” one paper might read after the Dow jumps half a point.

“Investors remain sidelined as concerns over XYZ dampen recovery hopes,” another might read on the same day.

On a daily basis it is simply impossible to know what goes on in the hundreds of thousands of minds operating hundreds of billions of dollars in the global markets. Maybe some hedge fund manager’s wife just left him…causing him to lose focus for a moment and to liquidate his position in XYZ instead of ABC. Maybe he got some inside information, which then turned out to be false. In that case he might be back in the office first thing tomorrow morning to buy the stock back. In reality, there are so many variables, so many separate and distinct inputs, that it is virtually impossible to draw a straight line between cause “A” and effect “B” in such a short timeframe.

With neither the patience nor the inclination to study such micro-term trends, we turn our attention today to those on a somewhat longer timeframe. One thing we can know with a reasonable amount of certainty is that we cannot consume a finite resource indefinitely. This applies to natural resources, like oil, just as it does to things like the patience of foreign creditors.

Much ink has been spilled on the subject of Peak Oil over the past few years. Although the issue has been more recently shelved in favor of global financial crisis headlines, the situation is hardly less serious than it was back when crude hit $147 per barrel a couple of years ago. In fact, despite the temporary downturn in global energy demand, the outlook may be bleaker now than it was then.

Last year the International Energy Agency reported that worldwide decline rates were roughly twice what they had forecast just one year earlier. (The previous figure of 3.4% was revised to 6.7%.) New, comprehensive research led the IEA’s chief economist, Fatih Birol, to estimate that supplies of conventional oil could begin to plateau as early as 2020…and that’s, he said, “assuming that OPEC will invest in a timely manner.”

Global Energy Outlook: Getting Worse Before It Gets Better originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

Your editor has no idea where the markets will go…only an inkling of where they ought to go. And where they ought to go is back to the mean, as everything eventually does. Right now, the S&P goes for around 22-25 times earnings, considerably higher than the long-term mean, which Yale University’s Robert Shiller has at 16.35.

Typically, investors do well to buy stocks when they are trading at between 5-10 times earnings. For instance, you could have bought the S&P for slightly less than 5 times earnings in the early 1920s. As we know, the index topped out later that decade, on Black Tuesday…when the P/E ratio hit 30. Provided you adhered to the mean reversion rule and sold before that fateful day, you could have bought the index back in ’32, again for around 6 times earnings. (It then rallied/bounced – to right around where it is now – before slipping back below 15 shortly after.)

For the better part of the next seven decades, the S&P 500 flew cautiously under the 25-times-earnings radar, on a handful of occasions even ducking back below 10. It wasn’t until the easy money days of the mid-’90s that the index waxed up its wings and launched into the clear blue sky. For a while, it looked as though nothing could spoil the flight. Then, in December of 1999, at the lofty P/E height of 44.2, the wax started to melt. The rest, as they say, is very modern history.

All this is not to say that the S&P is about to dive into the sea tomorrow. It’s more of a polite reminder to keep an eye on the altitude…

S&P P/E Ratios: Following the Icarus Flight Plan originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

But what’s this? It appears that a $787 billion stimulus package ain’t what it used to be, at least according to the Congressional Budget Office. The government’s spending watchdog (yes, such a thing exists) estimates that, all in, President Obama’s stimulus package will end up costing $862 billion, a $75 billion blowout. How did this accounting error come to pass, readers want to know? In painfully predictable fashion, the feds drastically underestimated the cost of unemployment compensation.

Who could have guessed? Well, anyone and everyone, really. This is the same government, remember, whose vice president warned that unemployment might breach the 9.6% mark if the stimulus program was not implemented, pronto. That was before the bill was passed…and before “official” unemployment went to 10.2% anyway. Including those workers categorized as “discouraged” and the millions who have taken cutbacks in hours, the real figure is closer to 22%, just 3% shy of the peak rate during the first depression.

Vice President Biden, who for some reason is allowed to continue squawking about the issue, defended the stimulus measures in an interview on CBS’s “Early Show” yesterday – the first anniversary of the bill.

“We’ve only been halfway through the act,” Biden assured citizens. “The job-creating portions are really loaded at the second half here.”

Lest Americans realize they’ve been sold a moonshine plan in a Pinot Noir package, President Obama weighed in to defend the spending. “Our work is far from over,” the president stated in his White House address, “but we have rescued this economy from the worst of this crisis.”

How does the president know this? In short, he doesn’t. It’s a guess. And probably a very bad one. Nobody can know what cometh tomorrow, nor can anybody know what might have been. Of all people, President Obama ought to know this better than most. Last year, for instance, he committed more than $3.5 billion of stimulus money to projects that he now wants to cut. How’s that for foresight?

According to a USA Today review of stimulus spending: “The president’s budget released this month recommends getting rid of Army Corps of Engineers’ drinking-water projects, which got $200 million in stimulus funds, and a US Department of Agriculture flood-prevention program, which received $290 million from the stimulus.”

Why give billions of somebody else’s dollars to moribund projects? Well, because they are somebody else’s dollars, of course. As long as public servants’ salaries keep rising and Beltway budgets continue bloating, who cares about the somebody elses of the world? The obvious problem with spending other people’s money is that, before it’s yours, it’s theirs. Politicians can extort money from their own voters through taxation at home, but where does the rest of it come from? With falling tax receipts (thanks to high unemployment levels), the government must increasingly rely on foreign investors’ contributions to the “somebody elses’ money pie.” The government calls these fundraising fêtes “Treasury auctions.” Unfortunately, foreign somebodies, particularly those in China and Japan, are becoming less and less excited about sending money abroad to finance American drinking water and flood prevention projects.

Poorly Defending Government Spending originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

First, the comprehensible: The greenback slipped about half a percent during yesterday’s trading. The papers attributed the selloff to allayed fears over Greece’s implosion and stronger economic data out of the States. For the sake of illustration, let’s pretend that Greece really is back to beach parties and ouzo-fueled debt orgies and that what passes for government “data” in the US is actually tenable (rather large concessions, you’ll surely agree). Why would people take the news as a signal to sell the dollar?

Curiously enough, the dollar is still considered by many to be the world’s most reliable currency, the island to which all flights of safety are destined. Ergo, when the tide of risk recedes (or is at least perceived to have receded), once-skittish investors emerge from their dollar-clad bunker to re-enter the world of reckless speculation. Financially speaking, the dollar falls during periods of economic peace and rallies during times of war.

The thinking behind this is, of course, utterly ridiculous. As far as safe havens go, the dollar is about as secure as a dam constructed out of papier-mâché. Some 97% of the dollar’s value eroded during the course of the last century…a third of it washed away in the past decade alone. Who in their right mind would store their wealth behind such flimsy protection? Apparently, dollar savers are attempting to build a brand new Atlantis. (There’s a Dubai World tie-in here…but we’ll leave that for another day.)

To be sure, it will take more than a single day and night of misfortune to sink the greenback. Nevertheless, there are still plenty of reasons to ditch the dollar sooner rather than later. The fact that foreign demand for US Treasury securities fell by a record amount in December might be a good place to start. According to the US Treasury Department, China, previously America’s largest foreign debt holder, sold $34.2 billion in Treasury securities during December. That leaves Japan, with a $768.8 billion stash, as the biggest holder of US government debt. Overall, net purchases of long-term US securities plummeted from $126.4 billion in November to just $63.3 billion in December, according to Treasury figures. Long story short, the most indebted nation in history is having trouble shopping its IOUs around. As a result, yields on long-dated bonds have been creeping gradually higher.

EverBank’s Chuck Butler explained the situation in yesterday’s edition of The Daily Pfennig:

“‘Indirect buyers’ are the foreign central banks, and they normally take down 40% of a Treasury issue. Well, last week, they took down only 28% of the issue… Uh-oh! But then, there were the ‘direct buyers’ upping their participation in the auction to a record level of 24%!

“Now, most of the market participants don’t have a clue what these numbers are telling us… The ‘direct buyers’ are ‘unknown.’ Yes, there is no way to tell who makes up the ‘direct buyers.’ For all we know, the Fed took down the entire amount! Why, you may ask, is this a problem? Well… if not for the ‘unknown buyers,’ the auction would have failed!

“To speak of a US Treasury auction and say that it failed would almost be akin to the day the earth stood still. We would see yields soar, and the dollar get deep-sixed. So until that day happens… every auction should become quite interesting, as long as the US continues to drive up deficit spending and keep rates at ultra-low levels.”

US Dollar: The Unsafe Safe Haven originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

Elsewhere in Asia, investors took stock of more earthly goings on…and hit the “sell” button. Indexes fell in Bombay, Tokyo, Sydney and across the Middle East. People are worried about the Greeks and the Dubai Emiratis. Both sovereigns are deep in debt. Both suffer crises of solvency…and both seek to delay their own Day of Reckoning, when debts must be repaid and promises met.

Last Thursday, European Central Bank President, Jean-Claude Trichet, hinted that the euro-nations would come to the aid of their struggling Mediterranean cousins, provided that Greece take “extra measures to make its recovery plan credible.” Mr. Trichet yesterday defended his decision to extend the monetary olive branch to Greece and sought to quell murmurs of incredulity among investors who, by Friday, were unsure whether the continent would abide a full blown bailout of the moribund Mediterranean debtor.

“When President Sarkozy, Mrs. Merkel, Silvio Berlusconi in Italy and President Zapatero in Spain, in his capacity as president of the European Union, sign the same document, it’s serious,” Mr. Trichet assured Europe.

As members of the dubious “PIIGS” club – Portugal, Italy, Ireland, Greece and Spain – leaders Berlusconi and Zapatero would seem to have a vested interest in erecting a bailout precedent. They will likely be panhandling around Europe in the not-too-distant future themselves. But what about the others? How many Berliners, for example, are comfortable sending their money on a Mediterranean vacation without them?

“Not enough,” would be our guess. A poll published in the German newspaper Bild am Sonntag indicates that more than half – 53 percent – of Germans support booting Greece out of the euro-zone altogether. And anger is growing within Frau Merkel’s own ranks.

“If we start now, where do we stop?” Michael Fuchs, deputy head of Merkel’s conservatives in parliament, remarked of the Greek question.

From the ruins of Greece to the Middle East’s modern day Tower of Babel, the threat of sovereign collapse continues to weigh on investor sentiment. Dubai, home of the world’s tallest building and scariest elevators, is yet to come up with a plan on how it will restructure its own rotten debt. News from Zawya Dow Jones over the weekend hinted that the state-owned Dubai World might offer creditors 60 cents on the dollar for the $22 billion it has outstanding.

Predictably, the cost of insuring against a Dububble default rose sharply in trading this morning. The WSJ reports:

“Dubai’s five-year credit-default-swap spread – a key measure of credit risk – widened around 0.23 percentage point to 6.50 percentage points in early trading Monday, according to CMA DataVision.

“The widening means it now costs around $650,000 a year to insure a notional $10 million of Dubai’s sovereign debt against default for five years, up from around $627,000 at Friday’s close. A month ago, it cost $421,000.”

Debts…deficits…bailouts and backstops; the question of whether to let the weakest hands fold is by no means a new one. Late in 2008 and throughout most of last year, politicians in the US wrestled with the question of whether this or that private institution was “too big to fail.” Being spineless politicians, they didn’t wrestle very hard. In most cases, public funds were poured into the most profligate pockets in an effort to “save” idiot institutions from their own actions. We noted as much in our coverage of this year’s Unofficial, Unauthorized Daily Reckoning Financial Darwin Awards. But transferring debts from private to public balance sheets doesn’t make them disappear. Eventually, they have to be repaid…or defaulted on.

Allowing Europe’s PIIGS to feed at the public trough will undoubtedly undermine credibility in the already embattled euro. (The sixteen-nation currency currently trades at an 8-month low.) Trichet & Co. can cut their swine loose…or they can follow them over the cliff.

Greece, Dubai and the Threat of Sovereign Collapse originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

All week we’ve watched with interest the goings on from our balcony. The labyrinthine corridors winding off the main roads are alive with excitement. Vendors busy themselves with final sales…children skip down the lanes alongside their parents…women scrub the windows furiously while their men prune the trees, finish up last minute renovations and generally scuttle about, making certain everything is “just so” before the celebrations begin. Even the old hunchback lady who – as far as we’ve been able to tell – collects the recyclables around our block, seems to have quickened her pace.

“Everything must be ready by weekend,” the man at our front desk told us. “It is much like…how do you say…a new slate. No…wait…a clean leaf. Well, you know, I sure.”

The Chinese New Year spectacle here in the ROC promises to be, at the very least, intriguing…but it will be nothing like what’s already underway over on the mainland. In China, as you read this column, the largest human migration on earth is taking place. During the next few weeks, hundreds of millions of people will shuffle around the country, most returning home from the pulsing cities in the east to visit their families in the countryside. Some will ride their bicycles or hitch rides with friends; others will fly for the first time ever; and still others will ride in comfort on the world’s fastest passenger train. The Ministry of Railways actually estimates that 210 million passengers – somewhere between the populations of Indonesia and Brazil – will ride the rails during the 40-day New Year travel season, a 10% increase over last year.

But aside from all the festivities, people want to know: What does the New Year, the year of the Tiger, hold for the world’s most populous nation? For the past twenty years or so the China Play has been more or less a one-way bet, albeit a rather volatile one along the way. China’s economy (as measured by GDP) doubled over the past twenty years…twice. But opinions on how it will proceed from here differ greatly. Legendary investors like Jim Rogers foresee a Middle Kingdom set to rule the world. Others, notably Jim Chanos, see China as the mother of all bubbles. “Dubai times 1,000,” he calls it.

So, what will it be?

Your editor has no idea, of course…only rough guesses and wild speculations.

(The tiger, in case you are the superstitious type, is said to be an extremely tumultuous sign. One website we read noted, “The year of the Tiger is very likely to be a volatile year, everything is taken to its limit in this big and bold year. It can also be a year of war, disasters and all kinds of disputes, it is a year for massive change…” Like we said… If you’re the superstitious type…)

When considering all things China – political, economic, social – it is near impossible to get anything right, except by accident. The numbers are big…the scale and velocity of expansion unprecedented…and the government unreliable, though predictably so. China’s hoard of Uncle Sam’s IOU notes, the world’s largest, is staggering…likewise are its strategic stockpiles of natural resources, from it’s own rare earth deposits to energy contracts around the globe to its rapidly expanding portfolio of foreign farmland. And that’s to say nothing of her swelling pile of gold…

But even if China does ascend to the heights some expect she will, the trajectory won’t be without corrections, overshoots and more corrections. Data released this past Thursday indicated a fierce acceleration in bank lending – despite the government’s prior efforts to “cool” the system – and a larger than expected bump in inflation. According to figures provided by The People’s Bank of China, lending by the nation’s banks totaled 1.39 trillion yuan ($203.5 billion) during the month of January, more than three times the 379.8 billion yuan extended in December and equivalent to almost 20% of the total target for the whole year.

Other stats, however reliable they may or may not be, showed that money supply – as measured by M2 – was up a whopping 26% at the end of January from the year-earlier month. China’s PPI (Producer Price Index) rocketed up 4.3% from the same period last year, accelerating from a 1.7% rise in December.

What does this mean? Does it suggest that the economy is overheating? Or can the increases be attributed to “outlier” events – the date the New Year festival falls on, for instance, or heavy snowfall in early January pushing up prices – as many analysts have been quick to suggest.

Again, we can’t say for sure…not with the certainty of an astrologer, in any case. But we do know that a drastic increase in the money supply leads, eventually, to a drastic increase in prices. And we’re seeing plenty of that.

The price of real estate, for one thing, is headed higher…much higher. Thursday’s same data dispatch showed that prices across the nation’s 70 largest cites rose 9.5% in January from a year earlier, quickening from a 7.8% rise in December.

Bubbling real estate prices, coupled with the aforementioned inflation figures, prompted China’s central bank late Friday to introduce further measures designed to curb bank lending. Large banks are now required to park 16.5% of their total deposits in the central bank. Smaller banks are already ordered to keep 14% of their deposits in the same coffers.

Will it work? Who knows?

Perhaps China’s central planners will achieve what has eluded generations of their central planner forefathers…perhaps they will be able to control, with levers and pulleys in the basement, the perfect flow of funds to exactly the right sectors at precisely the right time.

This year is not only the Year of the Tiger, it is the Year of the Metal Tiger, something that occurs only once ever 60 years in the Chinese calendar. In fact, the last time China rang in a Metal Tiger, Chairman Mao had just taken control of the land and promptly embarked one of the bloodiest experiments in central planning in history.

Of course, everybody knows astrology is just a bunch of baloney. Now, who wants to tell the Chinese?

Chinese Economic Outlook: What’s in Store in the Year of the Metal Tiger originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

First off, the nation’s largest company, Toyota, was forced to issue a recall for automobiles on three continents after it was revealed that the brake pedal on certain models had a tendency to “get stuck.” Consumers have become rather attached to the brake accessory on modern automobiles and didn’t take kindly to Toyota’s technical oversight. The company was forced to issue a worldwide public apology…then added that it will shut down five assembly plants in the US.

Then there was the somewhat embarrassing news – in the same industry, no less – that China has overtaken Japan as the world’s largest car manufacturer.

And, of course, there was that other stroke of bad fortune when ratings agency Standard & Poor’s threatened to downgrade the Japanese government’s credit rating, noting that Prime Minister Yukio Hatoyama is moving too slowly to reduce the nation’s soaring debt levels.

Bad luck in threes, you say? Hmm…

Your editor is gallivanting around Tokyo at present, enjoying the spoils of the deflationary spiral but ruing the stubbornly strong local currency. Prices continue falling…but the yen refuses to give an inch, even under threat of credit downgrades. Even so, a room that once went for ¥30,000 can now be had for a fraction of that amount. Restaurants and retailers engage in ruthless price wars in an attempt to stimulate demand from persistently frugal Japanese consumers. And, while Tokyo is by no means a “cheap” city to visit, it’s decidedly more affordable than it would have been back in the bubble years, before The Land of the Rising Sun underwent one of the most dramatic deflationary periods in modern economic history. Last year, while consumer prices among industrialized economies recovered about 1.3%, they fell almost 2% here in Japan.

But as Japan’s appetite slows, the rest of Asia grows ever hungrier. Along with South Korea, this tiny stretch of islands currently commands an inordinately large share of the world’s natural gas supply. Now, that trend is changing. As Chris Mayer observed in his essay “Liquid Natural Gas: The Next Resource Boom?” there are new players in the demand for this clean-burning fuel…and new ways to profit by investing in it…

Japanese Car Trouble originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."

Bruce Willis, eat your heart out.

Impressive as the finished products are, the concept behind Ishiguro’s androids is not entirely new. The Japanese government, after all, has embarked on one of the largest surrogate spending programs in history, using the government coffers as proxies for real world demand. But instead of birthing any honest, sustainable demand, Japan’s policy wonks and central bankers created an economic Frankenstein, one that has kept the country in an on again-off again deflationary recession for two decades. Turns out prices can smell faux demand from a mile away.

“Last August, it was reported that deflation in Japan had reached a new record,” observed Reckoner-in-Chief, Bill Bonner, in yesterday’s issue. “Prices were dropping at the fastest pace 38 years. By November, it was duration, rather than depth, that got the press’s attention. Prices had been going down for 10 months in a row…

“Prices fall in Japan. The yen rises,” continued Bill. “And the government uses every trick in the book – and some as yet unpublished – to knock it down. If you are in a position to borrow money from the central bank, the bankers will give it to you at practically zero interest. And if your neighborhood wants a bridge or a community center, that too will be forthcoming from the Japanese government. No government has ever been so generous. At least, not without going broke. For every yen the government squeezes from its taxpayers, it returns more than 2 yen in public spending.”

The problem, of course, is that “surrogate spending” cannot provide sustainable price support indefinitely. In the long run, it can only slow the rate at which prices go where they want to go anyway: down. It stretches a short, sharp correction over a much longer timeframe…and erodes the national balance sheet in the process. Moreover, because it is so difficult to measure the real-world value of the goods and services that surrogate spending “demands,” it tends to be immensely wasteful. People are put to work doing jobs that nobody would ordinarily pay for. Useless goods are produced at the expense of useful ones. And, as prices invariably drift lower, consumers employ the best defense against deflation yet known: they save, driving real demand down ever further.

Your editor wandered around the über chic Ginza shopping district today in search of that illusive real world demand. The streets are lined with high-end retailers…but the crowds are mostly to be found on the sidewalk and in the relatively cheap, but equally trendy, cafés and yakitori houses. Many people carry briefcases. Few carry shopping bags.

Consumer spending has been on a steady decline here since the government’s last stimulus effort began wearing off. Now, in the face of falling wages and easing consumer demand, central planners find themselves forced to make their next move. What to do? A front-page story on this week’s The Nikkei Weekly provides the answer:

“In a bid to prevent the nascent recovery from giving way to another economic tumble, the government last week enacted a second fiscal 2009 supplementary budget. But with the first stimulus partially suspended and its successor not taking effect until April, the economy, for the time being, is fending for itself.”

It is important to remember that not all demand is created equal. There is the kind forged in the crucible of the free market, rooted in sound money and underpinned by the desires of real people. Then there is the surrogate, government-sponsored variety, masquerading behind a lookalike, skin-colored sheath of public spending boondoggles and debased currencies. Administrations around the world are guilty of exactly this kind of economic prestidigitation but, as usual, Japan is way ahead of the curve. Unfortunately, that learning curve has cost the Land of the Rising Sun nearly a generation worth of growth and economic progress and plunged her government into deeper debt than any other nation in the world.

Central planners attempting to “imitate the imitators” with phony make-work programs and stimulus injections might like to ask themselves, therefore, “Will the real world demand, please stand up?”

Surrogate Consumer Demand originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today's markets. Its been called "the most entertaining read of the day."