Slowly but surely, the flow of funds out of assets and into cash that defined the vicious bear market of 2008 seems to be reversing. Certainly some investors who never dreamed that the Dow could fall below 10,000 in the first place are convinced that a bottom in stocks has been reached. But that's not the whole story.

Wiser investors, seeing a tidal wave of new money rolling off printing presses around the world, have lost enthusiasm for all the paper they had previously stuffed into their piggy banks. It is beginning to dawn on those fleeing to safety that they are heading in the wrong direction. After all, how much safety can there be in an asset where supply is exploding and demand is based solely on the false perception of safety? When perception catches up with reality, supply will overwhelm demand, and the price will collapse. In this case, price refers to the exchange rate of the dollar verses other currencies, or its value in terms of gold.

In addition, it is slowly becoming more evident that the global economy can function without American consumption. In March, auto sales in China surged another 10% to over 1 million units for the first time ever. In contrast, sales in the U.S. slid to just over 850,000 in March, 37% below last year's level. This marks the third consecutive month that Chinese car sales exceeded those in the U.S. As I have long forecast, the world is still producing cars, it's just that fewer of them are being purchased by overly indebted Americans, while more are being bought by an emerging class of Chinese car buyers.

Meanwhile, the February U.S. trade deficit narrowed to "only" $26 billion, a nine year low. Significantly, the improvement is not due to a surge in exports, but a collapse in imports. At first blush, one might conclude that a smaller trade deficit is bullish for the dollar, but the move is hardly sufficient to create any additional buoyancy for the greenback. A reduced trade deficit is welcome, but our account balance must actually move strongly into surplus if we have any chance of actually resolving the imbalances that brought our economy into crisis.

While a $26 billion trade deficit may seem small when compared to the $60 billion level that had become routine during the height of the bubble, the number is still large in absolute terms. A trade deficit of any size means that we are still injecting dollars into a global economy that is already saturated with an excess supply. Once our foreign creditors come to their senses, not only will they be unwilling to finance our somewhat smaller monthly deficits, but they will be unwilling to continue warehousing the trillions of dollars already in their possession as a result of funding our past deficits.

Ironically, just as the United States government ramps up its issuance of debt, smaller U.S. trade deficits mean that our trading partners now have fewer dollars to recycle into our bond markets. As the budget deficit explodes to nearly $2 trillion annually, slackening demand for Treasuries from abroad could be devastating. With smaller trade surpluses to recycle, nations like China will have diminished need to buy our debt. The argument supporting the "vendor financing" system that had developed between the United States and China always rested on their need to lend us money so we can keep buying their products. But if we are now using their money to finance government stimulus programs (including spending on education, health care, green energy, and corporate bailouts), this dog no longer hunts.

With these negatives building for the dollar, alternatives are emerging. Now that stock and commodity prices have stabilized investors are looking to other assets that offer higher yields and better long-term prospects. While most of the attention has been focused on the recent rally in U.S. stocks, few have noticed that foreign stocks are doing even better. The 20% rise in the S&P from its March low merely returns the index to its Oct 2008 low. In contrast, Hong Kong's Hang Seng index is now 40% above its October 2008 lows. In short, while U.S. stocks have merely treaded water, Hong Kong shares have surged 40%. Far from being dead, de-coupling is clearly alive and well. My advice is to take your seat on this train before most investors realize that it's left the station.

As 2008 came to a close, the Chinese economy was clearly struggling. Growth slowed to 9 percent in 2008, down from 13 percent in 2007. Consumer demand for products dropped domestically and overseas, resulting in massive job losses and many factories shutting down. This, coupled with deteriorating stock market returns, prompted Beijing to take an active role in restoring economic stability to the country. In November 2008, the State Council announced a RMB4 trillion ($585 billion) capital stimulus package.

While many details of the plan are still unclear, initial estimates appear as follows: RMB1.8 trillion ($263 billion) for construction projects including railways, highways, airports and electrical grids; RMB1 trillion ($146 billion) towards rehabilitating areas devastated by the Sichuan earthquake; RMB370 billion ($54 billion) directed to rural areas; RMB350 billion ($51 billion) to environmental causes; RMB280 billion ($41 billion) to strengthen the housing market; RMB160 billion ($23 billion) for independent innovation; and RMB40 billion ($6 billion) for health care and education. For this report, we are focusing on three key areas we think will benefit from the stimulus package - infrastructure, energy and agriculture.

Infrastructure
We believe the key areas in infrastructure investment are related to railways and transportation. In 2008, the Ministry of Railways had invested RMB350 billion ($51 billion) in basic construction projects. In 2009, the Ministry has nearly doubled its investment, allocating RMB600 billion ($88 billion) for basic rail construction. Railway development is expected to focus on the construction of passenger and regional express rail lines and the reinforcement of the Beijing-Guangzhou, Beijing-Harbin and Beijing-Shanghai lines.

China imported 443.7 million tons of iron ore in 2008, and that number is expected to increase as infrastructure construction ramps up. The Ministry of Railways estimates that by 2020 the total length of operational rail lines inside China will reach over 120,000 kilometers and that investment in rail construction will have exceeded RMB5 trillion ($732 billion).

Energy
The National Energy Administration announced several projects including new power plants, oil refineries, and a second west-east gas pipeline. Construction on the eastern section began in February 2009 in Shenzhen. Construction on the western segment began last year and is expected to be completed by the end of 2009. When operational in 2011, the 8,704 kilometer pipeline will cross 15 regions and carry 30 billion cubic meters of natural gas annually to Zhejiang, Shanghai, Guangdong and Hong Kong.

The completion of the second gas pipeline will help China decrease its consumption of coal. Currently, coal makes up 70 percent of the country's total energy consumption while natural gas only accounts for 3 percent of total consumption. The completion of the second pipeline is expected to save 11 million tons of coal every year.

China is also expected to double its nuclear power capacity in the next decade. Currently, China has 11 nuclear reactors in operation with a combined capacity of about 9 gigawatts. The target capacity for nuclear power is 70 gigawatts by 2020. The government has already approved the construction of 10 nuclear power reactors with a capacity of 1,000 megawatts each. Renewable energy and energy conservation technologies also were allocated a significant portion of the RMB4 trillion ($585 billion) stimulus package - RMB350 billion ($51 billion). The initial government expenditure of RMB25 billion ($4 billion) focused on nuclear, wind and solar energy.

Agriculture
The Ministry of Water Resources has begun the construction of hydraulic facilities in Xinjiang, Guizhou and Jiangxi. The purpose is to save water in major irrigation areas and improve drinking water in rural areas. The Ministry's plans include: RMB3 billion ($439 million) for drinking water projects covering a rural population of 15 million; another RMB3 billion to reinforce 320 large and medium-sized dams; yet another RMB3 billion for irrigation ditches; RMB7 billion ($1 billion) for water conservancy projects on major rivers and lakes; and RMB2 billion ($293 million) to speed up the south-north water diversion project. At the start of the year, the Ministry of Environmental Protection gave the go-ahead for 153 stimulus-package projects, with a total value of RMB470 billion ($69 billion), including 31 transport and water projects worth RMB139 billion ($20 billion).

We believe the 3 companies listed below will greatly benefit from the Chinese stimulus plan. They are a sound way to take advantage of these increased government subsidies.

Company #1

Company #1 is a railway infrastructure state-owned enterprise in the People's Republic of China. It was originally founded in 1948 and is headquartered in Beijing, China. The company offers transportation systems construction services. It builds railroads, roads, tunnels, and bridges and is the largest state-owned construction enterprise in the People's Republic of China.

The company operates in five business segments: Infrastructure Construction; Survey, Design, and Consulting Services; Engineering Equipment and Component Manufacturing; Property Development; and Other Businesses. The Infrastructure Construction segment designs and constructs railways, highways, bridges, tunnels, metropolitan railways, buildings, irrigation works, hydroelectricity projects, ports, docks, airports, and other municipal works.

Company #2

Raising the average income in rural and urban areas is among the major goals of the Chinese stimulus package. It will be the Chinese government's priority to raise the minimum grain purchase, boost agricultural commodity prices, and increase subsidies for farmers and low-income urban residents.

Company #2 has a defensive business model with diversified agricultural product-lines and economies of scale to benefit from favorable government policies. It is the largest producer of edible oil and the largest wheat and rice processor/exporter in China. The company has continued to add production capacity to capitalize on the Chinese' increased demand for healthy agriculture products.

Company #3

Company #3 is a specialist in electricity generation via wind power. The company has invested in 18 wind power enterprises throughout China and has been granted exclusive development rights by local governments to develop 6 gigawatts worth of large-scale wind farms throughout China. Also, the company recently formed a joint venture with China Light & Power Holdings to develop more wind farms in the future. Since renewable energy was allocated RMB350 billion ($51 billion) out of the RMB4 trillion ($585 billion) stimulus package, and since Company #3 is a major player in that sector, they should benefit from the extra allocation of funds to the industry.

As China tries to reduce its reliance on heavily polluting coal, windpower could play an important role in energy production.

Investing in foreign securities involves risks specific to international investing, such as currency and political risks. There can be no guarantees of success in pursuing any of the strategies we recommend, or that any of the specific companies will gain in value. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a financial accident resulting from the veritable explosion of global liquidity, increasingly risk-taking and its attendant volatility; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. Euro Pacific has not independently verified the information supplied by the company, and cannot make any representations as to its accuracy. This material is for private use of the subscriber; it may not be reprinted without permission.

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It was only two years ago, in early 2007, that subprime lenders and homebuilders began suffering under growing defaults. The global credit crisis had begun. Complicated financial structures - thought safe - began to unravel quickly after word spread that two highly leveraged hedge funds run by Bear Stearns were in trouble.

The eventual failure of those funds in July 2007 pointed a dagger right at the heart of over-leveraged banks, namely those that had made too many imprudent loans. When Northern Rock Bank failed in the UK later that summer, there was no doubt that the crisis was global in scope.

Financial crises are not new. They have recurred throughout monetary history, but became particularly prevalent after the formation of banks that loan out depositors' money. For example, the Bank of England was formed in 1694 and suffered its first crisis in 1696, which is just one of many episodes of financial panic in its long and storied history.

Crises occur for one simple reason - excessive credit expansion. There are recurring periods when banks loan - and borrowers borrow - too much, putting both in dire straights. These imprudent extensions of credit inevitably strain the financial capacity of both the borrower and the lender, as is so clear today.

In short, bank lending engenders the boom: their easy-money lending creates the illusions of prosperity. But prosperity does not come from borrowed money and consumption. It comes from savings and hard work, and those have been in short supply of late.

Credit today is no longer flowing freely because banks are trying to come to grips with those loans that will never be repaid. This reduction of credit, in turn, has taken the froth out of bubbly markets. Overpriced assets, such as housing and stocks, have sharply fallen back to earth.

Many see this wealth destruction and the contraction of credit that caused it as deflationary. However, the cost of living continues to rise. For example, the Consumer Price Index rose 3.3% in 2008. It climbed this January at an even faster annual pace. That didn't happen during the deflation of the Great Depression.

The point is that the dollar is being ever-inflated. Declining prices of houses, stocks and other assets are being measured with a currency that is being inflated. This serves to hide the true drama of their fall by forcing nominal prices upward.

The following chart presents the annual growth rates of M3, the total quantity of dollars in circulation. The blue line is based on Federal Reserve data, which stopped reporting M3 in February 2006. The red line is based on data complied by John Williams of www.shadowstats.com.

At its peak last year, M3 grew at a 17.2% annual rate. After the collapse of Lehman Brothers, annual growth was nearly halved, but was still an alarmingly high 9.8% in November. Since then, M3 growth has remained in double-digits.

Annual M3 growth rates exceeding 10% are not deflationary. The money supply is expanding, not contracting, and a contracting money supply is the main cause of deflation. A rapidly expanding supply of money - and double-digit growth rates are surely that - causes inflation.

The dollar is being inflated and, in my view, is on the cusp of hyperinflation. I expect this to become increasingly clear within twelve months. To understand why, one only has to look at the cause of hyperinflation.

Hyperinflation does not arise from banks lending too much money. It invariably occurs for only one reason - too much government spending. The money needed to meet this spending comes from the captive central bank, but some further explanation is necessary. Hyperinflation manifests itself in two different ways, which depend upon the nature of the currency system used.

For example, in cases such as Weimar Germany in the 1920s and Zimbabwe today, the central bank prints paper currency, which it then gives to the government to spend. In these countries, few people have bank accounts so the preponderance of commerce is conducted by cash transaction using paper currency.

The hyperinflation that wreaked havoc in many countries in Latin America in the 1980s was different. The banking systems in Brazil and Argentina were well developed and most people had bank accounts. Therefore, deposit currency was being used for the preponderance of commerce in these countries. So, instead of moving paper currency by hand to complete transactions, deposit currency was moved by check, plastic card, or wire transfer.

Cash currency was relatively unimportant in Latin America, so unlike Weimar Germany, no one was moving paper currency around in wheelbarrows during their hyperinflationary episodes. Instead, the central bank was busy creating bookkeeping entries to add currency to the government's checking account. As a result, people were seeing zeros added to their bank accounts, turning tens of cruzeiros and tens of pesos into thousands and even hundreds of thousands in a relatively short period of time. This is what I expect will happen as the dollar begins hyperinflating, and as I say is not too far away. The signs are already apparent. Here are some of the signs that a hyperinflation of the dollar is imminent:

1) Gold is rising against all the world's currencies. It has recently reached record highs against most currencies. Gold is a safe haven because physical gold is a tangible asset not dependent upon any bank's promise. Therefore, physical gold does not have counterparty risk. But it is not unreasonable to conclude that gold is also rising for another reason, namely, to protect against inflation. All the money being created by central banks around the world will prove inflationary; so, some people are likely accumulating gold because it is an inflation hedge.

2) Crude oil appears to have double-bottomed at $35. It is now back above $44, even though the US dollar has been relatively strong against other major currencies and demand has been dropping because of the weak global economy. Other commodities also appear to have bottomed. The CRB Continuing Commodity Index dropped 47.4% from its July 2, 2008 peak to its December 5, 2008 low, which clearly is a deep correction. But declines of this magnitude are not unknown in commodity bull markets. Regardless, this CRB Index is still nearly twice its February 1999 low of 182.95, which reflects the loss of purchasing power in the dollar this past decade. More to the point, the CRB is in a long-term uptrend even though the global economy has entered another great depression. We can conclude from this observation that commodity prices are not rising because of improved supply/demand fundamentals. Rather, commodities are moving higher because, as is the case with gold, physical commodities are tangible assets. They do not have counterparty risk, and they adjust to inflation with higher prices.

3) When adjusted for inflation, a bank deposit is losing purchasing power. Nominal interest rates are less than the inflation rate, so real interest rates are negative. Hyperinflation always occurs when real interest rates are negative. What's more, the Federal Reserve and most other central banks are pursuing a zero-interest rate policy, suggesting that negative interest rates will remain for the foreseeable future. Also, they are adding more inflationary fuel to the fire with their so-called plan for "quantitative easing", which is simply another way of saying that they will create more currency from more debt - "monetizing" they call it.

4) Few today understand the cause of hyperinflation, nor are prepared for it. More to the point, the prevailing psychology today contains a reckless blind faith in the Federal Reserve to get things right. It is general knowledge that the Federal Reserve made things worse during the Great Depression. Why should anyone expect them to get it right this time around? In fact, Ben Bernanke is pursuing policies identical to those taken by Rudolf Havenstein, the governor of the Reichsbank during Germany's hyperinflation. Mr. Bernanke is creating more currency by creating more debt, which is the singular underlying cause of hyperinflation.

5) T-bonds always provide an important leading indicator. Back during the highly inflationary 1970s and 1980s, someone coined the term "bond vigilantes". These holders of bonds would sell on the slightest whiff of inflation, forcing up interest rates, which in turn would stop the inflationary pressures that were building. The bond vigilantes are back, and here's why: last autumn when the Dow Jones and S&P were making multi-year lows, money flooded into T-notes and T-bonds, driving their prices to record highs (i.e., their yields went to record lows). The Dow and S&P have now fallen to make new multi-year lows, but the yields on government paper remain higher than last autumn. It is a glaring divergence. US government debt instruments are no longer providing the safe haven they did when stocks declined last autumn. It is also noteworthy that Bernanke's stated intention to buy bonds has not kept them from falling. The bond vigilantes are giving us a message loud and clear that inflation is coming.

6) Most importantly, the federal government has embarked on a course of runaway spending, and it is runaway government spending that causes runaway inflation. The budget deficit is projected at 12% of GDP, a shocking number. It has only been higher during World War II, and is more than twice the worst levels reached during the depths of the Great Depression. But it is likely that the federal government will exceed even this frightening target. The weakening economy will without doubt increase spending - for example, in growing unemployment benefits and more bailouts - while at the same time the weak economy will lower revenue. Together these will widen the deficit.

It is important at this point to ask, "Why does the Federal Reserve exist?" It is not for any of the stated reasons. The continuous, perennial inflation of the dollar makes clear that the Fed does not control inflation. Nor does it create employment, because private industry already does that. The Federal Reserve, just like every other central bank in the world, exists for one reason: to make sure that government deficits are funded, that politicians get all of the currency they want to spend. In the absence of any external discipline imposed on the central bank, as existed under the classical gold standard, the central bank will inflate the currency until it is no longer accepted. It is then buried in the fiat currency graveyard alongside countless other fiat currencies, which is where the US dollar is headed.

In his just-released annual report to shareholders, Warren Buffett had this comment on the federal government's actions to resolve the economic crisis: "This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone 'all in.' Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation."

He reemphasizes the inflation risk later in his report by commenting: "I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price." He also notes that "when the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary...Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long [because] cash is earning close to nothing and will surely find its purchasing power eroded over time."

Mr. Buffett stops far short of forecasting a hyperinflationary collapse, but his message is clear nonetheless. Inflation is a risk, to which I would add, hyperinflation is the real risk. In a world of fiat currencies, the only escape is the precious metals. So, now more than ever, own physical gold and physical silver.