Bank stocks in America were absolutely hammered in Tuesday trading. Citigroup (NYSE:C) was down 20%. Bank of America (NYSE:BAC) was off 29%. And Wells Fargo (NYSE:WFC) was off 24%.

--What gives? It's the sinking feeling that the world's banks still don't have enough capital and will need much, much more to offset coming losses and begin lending again in normal way. But the equity capital just keeps melting away. For example, the Royal Bank of Scotland had a market cap of £75 billion two years ago. As of yesterday, it was only 4£.5 billion pounds. And that's AFTER a taxpayer injection £32 billion!

--More on what this means for Australia in just a second. And later this week, we'll get into the real heart of the problem in the banking sector, dwindling capital and mismatched liabilities and assets.

--But for now, let's be clear: the banking crisis has entered a new stage in the equity markets. It has real world consequences for commodity demand and resource shares. We'll get to that in a second. But what about Australian financial shares?

--Well, we won't get into any analysis of loan books or balance sheets. It is true that Australian banks did not get into the subprime mortgage game. But it is also true they did make a lot of loans to margin lending firms in the stock market and still have significant exposure to residential real estate. We asked SWARM Trader Gabriel Andre to put that all aside and tell us what was the worst looking Aussie bank stock on a technical basis.

--Here's what he told his readers yesterday in a SWARM alert. His analysis included a forecast for the ASX/200. "Among the losers," Gabriel wrote, "there may have one famous banking institution. Besides the balance sheet and the macro news, we had a look today at the Aussie banks. Just on the chartist side. Only with technical indicators. And there is one chart that does not look really good. It's ANZ. Take a look at the chart below.

--"The key level is at $15.5. It has been the main support of the price action during several months (points A, B, C and D) but has been cleared in November (point E) when the price went further down to a low of $12.30. The key level of $15.5 mechanically became the new resistance. Hit a few times since the beginning of the year (points F and G), the resistance has been holding firmly. The long-term resistance (red line) is also just above. The price action is therefore well capped."

--"Two different momentum indicators have already turned bearish: the MACD and the Klinger oscillator, which is sensitive enough to signal short-term tops and bottoms, yet accurate enough to reflect the long-term flow of money into and out of a security. This afternoon ANZ is quoting $13.7. It should go clearly further below, especially if the ASX ban on shorting the financials will expire next week."

--Maybe ASIC and the ASX will reconsider the ban on shorting financials. And maybe it will not matter anyway. Either way, stay tuned.

--We wrote above that the renewed banking crisis is bad news for commodity demand and resource shares. But how so? The problem is asset deflation.

--Yesterday we speculated that there could be trillion dollars more in credit-market losses related to commercial real estate, residential real estate, and corporate bonds. If that is the case, it means much lower share prices. It also means finance is going to be extremely tough to come by for mining companies, who are facing falling real demand to begin with.

--Today Nouriel Roubini checked in on the issue of how much more asset deflation we face. At a conference in Dubai he said, "I've found that credit losses could peak at a level of US$3.6 trillion for U.S. institutions, half of them by banks and broker dealers...If that's true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis."

--Now you can see why it was such a bad day for the banks. The scary fact is that Roubini's estimate could still be conservative. You still have the corporate bond market, securitised consumer loans (credit cards and loans), and GSE and Agency-backed bonds (both of which are tied to U.S. residential real estate.)

--But quibbling over trillions is not the point. The point is that if there is more asset deflation to come, it is extremely hard to find any positive argument for continuing to own, much less buying, all but very specific types of commodity-related investments. And just what would those investments be?

--We turn to the late Harry Browne for the answer. In the early 1970s, Harry wrote a book called "How to Prepare for the Coming Devaluation." Harry's book was an investment primer on how to live in a world with massive, deliberate debasement of national currencies. Naturally, the strategy favoured "stuff" over "paper." But not just any stuff.

--It was-and still is-a radically simple asset allocation model. Harry said that roughly 25% of your assets should be in gold (combination of bullion, coins, and equities), 25% in foreign bonds, 25% in U.S. Treasury bonds, and 25% in growth stocks.

-- Investing: once complicated, now simple!

--Would that model hold up well today? Well, we'd be wary of having money in the bond market. That's one thing that's changed since Harry wrote his book in the 1970s. And we'd probably add more energy investments, given our subscription to the Peak Oil theory of declining global oil production. But his observation that simpler is better when preparing for inflation is spot on.

--An actively managed portfolio with a weighting of 60% to 70% of your assets in stocks does not look like a financial survival strategy for the next five or ten years. You want a more permanent portfolio that takes into account the macroeconomic and monetary events that influence share prices.

--Harry's big call was to buy gold and silver. And as you know, that worked pretty well. Buying gold has also been Bill Bonner's trade of the decade since 2000. It's working out pretty well too.

--But did you know that there's a fund that's traded since 1996 which essentially imitates Harry Browne's investment strategy? It's called the Permanent Portfolio and trades under the symbol PRPFX. Note that we are not recommending you buy the fund.

--What we are recommending is that you pay close attention to its strategy. "Designed to provide growth at low risk," the home page says, "the primary goal of Permanent Portfolio is to preserve and increase the real long-term purchasing power of each shareholder's investment, regardless of economic climate. "

--It does this with a portfolio consisting of gold, silver, Swiss Francs, real estate, U.S. Treasury bonds, and aggressive growth stocks. Take a look at how the fund has done since its inception versus the S&P.

--As you can see, the Permanent Portfolio got clobbered during the tech boom. It's relatively low allocation to growth stocks had it underperforming. Then, starting with the great Greenspan reflation of 2003, it roughly tracked the S&P 500, while still slightly underperforming. However, since late last year, it's held up much better than the S&P 500 as the financial crisis decimated stocks.

--By the way, here's how the fund's assets were allocated at the end of last year:

Gold: 20%

Silver" 5%

Swiss Franc Assets: 10%

U.S. and Foreign Real Estate and Natural Resource Stocks: 15%

Aggressive Growth Stocks: 15%

U.S. Treasury Bills, Bonds and Other Dollar Assets: 35%

--We might have fewer U.S. dollar bonds and more growth stocks in there too, but what's killed the Permanent Portfolio in the last six months is its exposure to commercial real estate through its REITs. We mentioned last week that we thought arable farm land would be an increasingly valuable asset in the coming years. So if we were going to make this union of asset classes even more perfect, we would strip out the REITs and backfill some agriculture and land investments.

--But the rest? It looks pretty sound for a world where you face more asset deflation prior to rampant, government-backed inflation. The 80% up figure translates to about six percent a year since its inception, which is just about the historic return for common stocks (if you include reinvested dividends).

--One other item to note about this. The Austrian School's analysis of the credit cycle is what informed Harry's strategy. Like today, he understood that changes in the money supply would affect the real economy and the stock market. The credit cycle and the business cycle are inextricably bound together.

--But that didn't mean there isn't a prime place in Austrian theory for the role of the entrepreneur. In fact, the great Austrian economist Joseph Schumpeter pointed this out in his early work, The Theory of Economic Development. Schumpeter pointed out that the aim of all economic production is to satisfy human wants.

--In Schumpeter's world, the entrepreneur is more important than the capitalist because it's the entrepreneur who has the vision to challenge conventional ways of doing business and take risks (albeit with someone else's money.) In Schumpeter's vision of capitalism, "the gales of creative destruction" are unleashed by single-minded entrepreneurs who bring change. And not just change you can believe in, but profitable change!

Or as Schumpeter writes in The Theory of Economic Development , "Entrepreneurial profit ... is the expression of the value of what the entrepreneur contributes to production." This is why Schumpeter's kind of capitalism is inherently moral and ethical. It is based on production which consumers find valuable and exchange which they enter into voluntarily.

--There is no compulsion or arbitrary setting of prices or government-mandated production or lending. If the idea of the entrepreneur contributes to the production of some good or service people want more of than what's already available (or if it's entirely new) he profits. And sometimes enormously so.

--That is one good thing we can say about the world we live in and one big reason why growth stocks should remain part of your asset allocation strategy. In medicine and energy, the world faces huge challenges and enormous entrepreneurial opportunities. It's going to present investors with great chances to share profits from innovative firms.

--With great volatility you also get a lot of innovation. As much as we focus on value destruction here in the Daily Reckoning, there are a lot of wealth creation stores to be pursued too!

--But we'll have to save the story of creative destruction for tomorrow! In tomorrow's edition, we tackle the issue of fair value versus market value in the U.S. mortgage market. And we'll have more on AGMOIL, the next trade of the decade involving a portfolio of agriculture, precious metals, and oil. Until then!

----------------------------------