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From Dan Denning at the Old Hat Factory:

The two biggest stories affecting Australia this morning come from neighbours in the North, Japan and China. In Japan, GDP contracted at an annualised pace of 12.7% in the fourth quarter. It's the worst quarterly performance for the Japanese economy since the oil shock of 1974.

The oil shock caused a contraction in trade by putting up the global price of energy. Today, energy is comparatively cheap. But the whole financial system that developed following the oil shock is now falling apart. Trade is contracting. Interdependencies between national economies are being exposed, strained, and sometimes broken.

How many States will fail in the coming years? Mexico? Pakistan? China? America?

The Japanese import a lot of Australian thermal coal and iron ore. They use that energy and that steel making materiel to export finished goods to China and America. An-export based economy probably isn't going to fare all that well in a world depression.

Keep in mind, Japan's public debt-to-GDP ratio is 180%. Ever since its own bubble in stocks and real estate popped in 1989, the government has tried to step in and restore consumer confidence, spending what household's won't.

It hasn't worked, of course. And the whole structure of the Japanese economy is oriented to exports and competitive currency devaluation. The local population, where more people die than are born, is shrinking. What can the government possibly do to reverse a demographic trend like that?

Japan's slow-motion, demographic, and Keynesian decline is a problem for Australia. But there is a more urgent issue to deal with in the pursuit of Australian resource assets by the Chinese. Is it good? Is it bad? Is it inevitable?

Distressed Oz Minerals has accepted a $2.6 billion takeover bid by Chinese state-backed metals trader Minmetals. Oz has been unable to strike a deal with its bankers, who are otherwise preoccupied with their own survival. As a result, part-ownership of the world's largest zinc mine in Queensland and the promising gold and copper mine at Prominent Hill in South Australia will be shared with Australia's strategic partners in China.

Nobody wants to own or operate zinc or nickel mines at the moment, apparently. That is probably the single best time to be a buyer. You get a good price.

But wait! We interrupt your regularly scheduled daily dose of scepticism and humour with a complaint. It's one we often get.

"It's easy to criticize everyone else. But what's your plan!"

First off here's an important point: the Obama/Geithner plan is a plan that prevents plans. It doesn't cut government spending. It just spread the wealth around on things that don't fundamentally change America's position in the world (which is not good).

Second, the Obama/Geithner plan actually prevents anyone else from making plans! Because it doesn't address the insolvency of America's (and the world's) banks, it means no other entrepreneurs can make plans themselves, because they can't get money from banks...who aren't lending because they don't want to sell their bad assets at a discount when they think they can get the government to pay full price later!

It's a plan that perpetuates the miserable status quo. But then, that's what stability is, isn't it! You freeze things just as they are, believing that a lack of movement is actually progress. It's nuts.

What we need is more instability. The world can't move to a new production possibilities frontier until we move away from the old, failed, field of our last boom. The Western world needs a giant intervention, where it admits to itself that the thirty-year flirtation with financial capitalism produced a boom on Wall Street and a fictitious housing boom that didn't leave households or national economies any wealthier.

It was a giant misallocation of resources based on the vague idea that you can spend your way to prosperity and enjoy life on credit. That's not the world we live in. So the sooner we get past trying to "stabilise it" the better.

In that spirit, we present our plan to save the world. The plan is in no particular order. And all of its premised on one big important action to take at all costs: abolish the Federal Reserve and let there be a free market for money and a natural rate of interest. After that, the following steps should be taken:

1. Reduce the wages of all elected officials to the national median income. If they mismanage the nation's finances, laws, and future, they certainly shouldn't be compensated for exemplary performance. Public service shouldn't be a lucrative career. Throw them in prison for a year if they can't balance the budget.

2. No more raising the statutory debt level. You can keep rewriting the law to allow yourself to spend more money you don't have.

3. Declare a one-year moratorium on payroll taxes. The most important stimulus check anyone gets is from his employer. Let people keep their money and they'll spend it in the way they want. Get government out of your pocket.

4. In the spirit of "bold experimentation," allow cities and states to establish real "free enterprise zones" where small and large businesses enjoy a five-year tax moratorium on new investment and profits. Do you want to see high-wage manufacturing jobs return to Western shores that are accompanied by high rates of capital investment and employment and income growth? Then let Detroit be more like Hong Kong. Turn Baltimore into Taiwan.

5. Allow R&D tax credits for green technology. The private sector will be far more willing to fund green investment than the government, if the incentives are there. So change them.

6. Let businesses expense capital expenditures rather than depreciate them over time. This is what FedEx founder Fred Smith advocates. He reckons it will increase long-term business investment and get us away from a culture of chronic short-term financial and earnings management, which has proven a disaster for shareholders.

7. For America, bring home American troops from Japan, Germany, Okinawa, South Korea and the dozens of other countries they're in. It's not popular in those countries. America can't afford it. And if the world doesn't want it, then America shouldn't be trying to export security or a set of political beliefs. Let people take responsibility for defending themselves and stop intervening in their lives. Enough is enough.

8. The government must stop making promises it can't keep and naive taxpayers should grow up and realise these promises can't be met except through theft and redistribution, both of which make an economy poorer. Let's admit that that State-sponsored retirement benefits will have to be means tested and the retirement age will have to be raised. Is it fair to change the rules on people who've invested their whole life believing they'd be able to retire? No. But life is not fair. The world has changed. We can either admit it and try to adjust in a humane way so that the social safety net that's there doesn't collapse altogether. Or we can stubbornly cling to the notion that it'll all be right. It won't. It isn't. And we had better be realistic about it soon, or we are doomed.

9. Let's finally adopt a balanced budget amendment and make it illegal for Congress or national governments to run deficits. Economists will say it is unrealistic and that the government needs the flexibility to borrow and spend money when the private sector and households can't. But all this has ever gotten us is more wars and the long-term expansion of government programs which we now know we can't pay for and generally don't work very well.

10. End the costly, ineffective, and militarising drug wars that put local police at war with ordinary people. The drug war fills the legal system with petty offenders and turns civilized society into a police state. Give up on trying to coerce people into a drug-free life. Persuade, don't legislate. Punish behaviour, not lifestyle. If you de-criminalise drug possession (not abuse i.e. driving) the price will come down and the incentive to commit violent crime to get a piece of the drug trade will be gone.

There are other issues like education, healthcare, and Steven Segal films. But those are beyond the scope of this plan.

Also, we recommend reinstituting a poll tax and or an IQ requirement for voting. Either that, or you must actually pay taxes (rather than being a net recipient of government benefits) in order to vote. Otherwise, the population is going to keep voting itself money it doesn't have.

See? How easy is that?

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And now over to Bill Bonner in Los Perros de San Jose, Nicaragua:

Remember our dictum: the force of a correction is equal and opposite to the deception that preceded it. As we looked out over the absurd hallucinations, delusions and lies of the Bubble Years - oh, those happy days! - we warned that the coming correction "would be a doozy."

And a doozy it is.

'Doozy' is a technical term we feral economists use. "Depression" is what most people call it.

"Slump worst for 50 years," is the big headline in the Financial Times over the weekend.

"Data reveal recession worst than feared."

And the full weight of it has yet to fall upon the economy. A correction takes times...especially when it is not merely a cyclical recession, but a structural depression. The whole structure of the world's economy is being reshaped. The banking system is insolvent. Thousands of businesses are broke. Millions of households are upside down financially. Joblessness is rising into the tens of millions and may reach 100 million worldwide.

"One of the severest downturns in generations," said U.K. Chancellor Alistair Darling.

The downturn is going to be tough for almost everyone, almost everywhere. The French have to learn to live with fewer tourists at home and fewer bottles of champagne exported abroad. The English have to learn to live with less revenue from financial services. The Chinese - and Asians generally - have to figure out what to do with all those TV sets that junk Americans aren't buying anymore. Arabs wonder what to do with their oil.

Americans, meanwhile, have to figure out how to get by in a world where strangers aren't so kind. You'll remember what made the world go round this last quarter century. Those nice strangers made things and shipped them to Americans. The Americans paid for them with I.O.Us. The foreigners were so accommodating, they never asked for payment. Instead, the I.O.U.s just piled up in their vaults.

All that has come to an end. Trade is collapsing. And now it's every man for himself. Sauve qui peut. Americans aren't buying. Chinese aren't selling. So far, the strangers are still being nice about America's I.O.U.s. They're politely holding onto their Treasury bonds and not insisting on payment. But they've made it clear that they're not exactly looking for a lot more of them...not when the value of America's collateral is falling so sharply. And they've made it clear that if the United States lets these I.O.U.s go down anymore, they won't be very happy about it.

But what we're wondering is whether we should add a corollary to our dictum: Yes, the force of a correction is equal and opposite to the deception that preceded it. And the measures taken to stop the correction will be just as absurd as the crackpot ideas that got the economy into trouble in the first place.

We don't know what particular good this insight does for us. But it just shows that the show isn't over. One hallucination may have run its course, but there are plenty more. And they have consequences too.

What the world waits to see is how long it takes these consequences to reveal themselves. No one doubts, broadly, what the consequences will be. Governments are doing their level best to create inflation. Sooner or later, they'll get the hang of it. But when? How?

That's the thing...no one knows. The depression is taking the stuffing out of prices. Trillions in nominal purchasing power have disappeared. Workers have been laid off by the millions. There are too many Starbucks...too many malls...too many factories. All these things are dragging down prices...even while the feds inflate the money supply. Where will the turnaround come? When will prices stop going down and begin going up?

No one knows...