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From Dan Denning at the Old Hat Factory:

--Buenos Dias. Welcome back from your ANZAC day weekend. The obvious story to lead with to begin the week is the outbreak of swine flu in Mexico. But as there is nothing any of us can do about that, we'll report that Chinese gold reserves have grown 75% since 2003 to over 1,000 tones. That's small compared to countries like the U.S. and Germany. But it's growing.

--In the markets, all the really interesting action is happening behind the scenes. On the surface, things appeared to get better on Friday. In the U.S., Ford told investors that it lost $1.4 billion in the first quarter. Apparently this was less than analysts expected. The Dow closed up 1.48% and climbed back over 8,000.

--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 them 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.

--The insiders are probably not paying attention to the first quarter earnings reports that are responsible for the current rally. They're looking at the rest of 2009 and probably planning for more layoffs. If they think the rally is over, it probably is. 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.

--We'll get to whether that could happen in Australia (or already is happening). But 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 Night Blindness, "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 a$356 billion (£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 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. This is what Australia is hoping to do.

--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 going to 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 awhile 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.

--What about Australia? Well the annual budget deficit that results from next month's budget is probably going to come in around 5% of GDP, which is not bad compared to 12.3% in the U.S. or 12.5% in the U.K. But it's going to be around $50 billion. And remember, just over a year ago, you were looking at a surplus of $22 billion. A $72 billion one-year swing in Australia's public sector finances is an impressive accomplishment by the Rudd government, but probably not one it will be campaigning on next time around.

--In February the government raised its borrowing ceiling from $75 billion to $200 billion. Last week, Finance Minister Lindsay Tanner said the bleak IMF report highlighted the big revenue gap in Australia's budget. He said Australia might have to raise its debt ceiling to $300 billion.

--This is the nice thing about being a sovereign government. A household cannot arbitrarily vote itself the power to go deeper into debt. Households are at the mercy of their creditors. This either forces households to live within their means, or forces lenders to be more discrete with their loans.

--A sovereign government generally doesn't face the same kind of restrictions on its ability to borrow. The only real restriction is that it doesn't much up its public finances so badly that creditors begin to demand higher interest rates. Or even worse, turn their back altogether.

--Granted, Australia's funding needs look pretty modest in the global scheme of things. But the question we ponder to start the week off is whether the Rudd government can trash the country's credit rating even more quickly than anyone expected.

--Australia's triple A credit rating could indeed be at risk, according to an article in the Sunday Age. S&P sovereign risk analyst Kyran Curry says his agency is watching Australia's current account deficit to determine if the government is borrowing more than it should. He says the current account deficit shows both Australia's need to import capital and the effects of declining export revenues (an even larger deficit).

--He wasn't ringing any alarm bells just yet. But it was pretty clear what he meant. "We believe this Government will develop a credit exit strategy to stabilize its fiscal (budget) position in the medium term...But if the balance sheet weakened (the current account deficit), combined with a further weakening in the fiscal position (the budget deficit), that could bring some pressure on the rating."

--"Pressure on the rating," means higher borrowing costs for the government in the future. That makes all sorts of financing more expensive, and exposes Australia's big vulnerability, its reliance on foreign capital to grow the domestic economy.

--So how big would an annual deficit have to get before the ratings agencies downgraded sovereign Aussie debt? "It is believed a deficit of $60 billion or more could prove a trigger point for ratings agencies to re-think the outlook, which would lead to higher interest rates and a bigger taxpayer-funded public interest bill," the Age concludes.

--David Uren in the Australian writes that it could come sooner than you think. "The crunch point for government borrowings will be reached in 2010-11, when government bond issues totaling $17 billion fall due, compared with just $6billion in 2009-10. This would potentially lift the financing requirement in that year to well above $70 billion, requiring the Treasury to issue bonds at a rate of more than $1.3billion a week."

--The job of borrowing $1.3 billion a week from the rest of the world falls on the shoulders of Andrew Johnson, the Chief Executive Officer of the Australian Office of Financial Management (AOFM). Good luck to him on that.

--Mr. Johnson gave a speech in Sydney last week called, "Australian Government Debt in a Changed Financial World." In that speech he said, "If we were to continue our current pattern of bond issuance at the rate of $1 - 1.4 billion per week, this would provide $48 -$ 67 billion over the course of 2009."

Source: www.aofm.gov.au

--Lets be clear, we're not saying the AOFM is going to have trouble selling this much Aussie debt. Some of it will be bought domestically by super funds. Some will be bought by European and North American financial institutions. And some will be bought by the Chinese we reckon. One clear result is that non-residents will end owning a larger piece of Australian government bonds than ever before.

Source: www.aofm.gov.au

--Maybe it's good that foreigners want a piece of Aussie debt. Maybe that means the place remains attractive to foreign capital. And maybe it means the government can run even larger deficits in the coming years without paying substantially higher interest rates. But maybe it also means the Aussie dollar is headed down soon.

--Over to Alan Kohler at Business Spectator who writes that, "International investors will not buy Australian government debt at a yield of 4.7 per cent and an exchange rate of 70c/70¥, when debt levels are at the point where a negative rating watch is likely, if not an actual downgrading." Alan predicts/suggest that the Reserve Bank ease the government's borrowing pain by lowering the cash-rate to two percent by June 30th.

--It's just over two weeks until Wayne Swan has to present his budget. But we'd expect currency and share markets to start putting the pieces together before then. The weaker Aussie dollar ought to be a bonus for the Aussie gold price (and investors in gold shares). Meanwhile, another big question is whether the share market can keep up its recent run.

--You know our take on it by now. Deleveraging and liquidation have a long way to go. There are many more housing-related losses to take for U.S. and European banks (not to mention emerging market debt). Governments are trying to spend their way out of it, and in the process they're jacking up tax rates to soak the rich.

--Bottom line? The plan to borrow and spend our way out of the recession isn't going to work. The results of the stress tests for U.S. banks are due the first week in May. But the bigger stress test is going on in the bond markets right now. It's a stress test for sovereign governments in the U.S., the U.K. and here in Australia. Who's going to pass and who's going to fail?

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And now over to Bill Bonner in Buenos Aires, Argentina:

"How do you feel now?" asked a reporter for a local investment magazine. "I mean, you're a contrarian...and you were right about so much?"

"Not exactly," we explained. "Yes, we saw the problem coming. And we expected the government would do all the wrong things - which it has. But we never imagined that they'd do so many stupid things all at once."

There are only two examples from modern history of depressions such as this - the '30s in America and the '90s in Japan. Both times, the governments did stupid things. But this time, the U.S. government has outdone them all. They've committed $13 trillion to programs that make no sense theoretically...and have never worked when they've been tried.

If you'll recall, the dog that bit the world economy was rabid with debt. The feds are trying the old 'hair of the dog' technique. But they've rounded up every mangy cur and stray bitch in the country. And now they're adding debt to the world economy at a much faster rate than ever in history.

Of course, as feral economists, we love it. We never thought we'd see such a thing. Gone are the mealy-mouthed reservations of cautious economists. Gone are the hesitant...hedged...halfway measures. They're pulling out on the stops. It's the pedal to the metal...its hell for leather...

What a bold experiment! What a brave undertaking! What a crackpot thing to do!

They must think the planet is under attack from aliens. It's as if the survival of the human race were at stake. Nearly the entire output of the largest economy on the planet for an entire year - debt, not savings - is being spent to...to...to...well...to do what?

To try to stop the speculators from getting what they deserve!

But wait...it gets even madder. Of course, if you put food out in the alley, it's bound to attract rats.

Not surprising then, that the government's bailout cash is giving rise to an astonishing number of new fraud and money laundering accusations.

The complex nature of the bailout program makes it "inherently vulnerable to fraud, waste and abuse, including significant issues relating to conflicts of interest facing fund managers, collusion between participants, and vulnerabilities to money laundering," says an internal government report.

"You don't need an entirely corrupt institution to pull one of these schemes off," said an expert. "You only need a few corrupt managers whose compensation may be tied to the performance of these assets in order to effectively pull off collusion or a kickback scheme."

But don't worry. The feds are on the case. They're said to be investigating. Just the way they did with Bernie Madoff. And who knows? Maybe the crooks will tell their families...and maybe the sons and daughters will turn them in, just like they did with Bernie.

There are always a few rotten apples in every barrel. But from here at The Daily Reckoning's South American headquarters in Buenos Aires they all look brown to us. Even Business Week magazine opines that the whole bailout program is nothing more than a scheme to pick the pockets of the nation's retirees in order to give the money to rich bankers.

"Monday afternoon, Goldman Sachs (GS) reported much larger than expected first-quarter profits on the heels of the strong earnings Wells Fargo (WFC) reported last week.

"No one should be surprised.

"The Fed has permitted the banks and financial houses to park vast sums of unmarketable paper on its books - securities made nearly worthless by the misjudgment and avarice of bankers. In return, the Fed has provided these paragons of finance with fresh, cheap funds to lend at healthy rates on credit cards, auto loans, and even mortgages.

"While the Fed cuts the banks slack, the bankers are busy turning the screws on their debtors by raising credit card rates and fees, and harassing distressed borrowers with all the zeal the Roman army displayed sacking Palestine.

"It takes good banking skills to borrow at 3%, lend at 5%, and make a profit.

It takes much less business acumen to borrow at 2%, lend at 5%, and make a profit - which is exactly what has happened. The extra fees are just gravy.

"This all comes at a cost to someone - America's elderly.

"Many retirees depend on interest from certificates of deposit. Those rates are down dramatically and as CDs expire, retirees are compelled to reinvest their savings at lower rates and live on less income. They can take comfort that their sacrifices are helping pay off Wall Street's losses from the lavish bonuses that were paid bankers - for example, the $70.3 million Goldman doled out to CEO Lloyd Blankfein in 2007."

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