- Bob Dylan

A few months ago, working on Wall Street was about the most prestigious thing you could do. Rock legends earned less. Heart surgeons got less respect. Porches had less power. Screen stars had fewer girlfriends. You were on top of the world. You earned more than anyone else. You knew more. You were better educated...the top of the class from the top schools. You understood what a CDO was...and a swap...and a derivative.

Naturally, other people...ordinary people...looked up to you. They gave you good tables at restaurants. They parked your car without scratching it against a fire hydrant. Women wanted to meet you...and men asked your advice on economics, politics, fashion, art - you name it. You were what every mother wanted her son to be - a member of that special club...the secret order...the high priests of the modern world...the ruling elite of Planet Goldman...the Confrérie of Finance.

But now, they that did ride so high now lie in the gutters of lower Manhattan. People practically spit at you on the street. They blame you for their losses...for taking away their retirements...for wrecking the whole world's economy. You were a hero...now, you're a schmuck.

Yesterday, the Dow fell another 427 points - to under 8,000. This morning, stocks fell, as recession fears and jobs data plagued the market. O' Bama! Where is thy bounce!

Consumer price inflation fell by 1% - the biggest drop in history.

Houses in Southern California are now down 41%, according to the latest report. "Harsh reality," says the Wall Street Journal, is now "hitting home."

Architects, too, say their billings have taken a record dip.

About the only profitable business left is hijacking ships!

The typical stock market investor has lost about half his money. He's looking for someone to blame - surely, it's not his own fault!

And so now, poor Wall Street, the public is catching on to your scam...

...that the special knowledge you claimed was nothing but smooth talking claptrap...

...that you really didn't know any more than anyone else about what was actually going on...

...that what you were doing was skimming money from honest businesses with a lot of fancy shenanigans and unnecessary transactions...

...and selling stocks to naive lumpen - claiming that equities "always go up in the long run"

...and loading up business and consumers with more debt than they could carry...

...and then greasing the debt over to investors, softly assuring them that "our models show the risk of default is negligible...it won't happen, not in a thousand years."

That was only a few months ago. And now the debt has gone bad - trillions worth of it. And now, so many things that Wall Street promised have turned out to be lies and humbug that the whole world financial system has seized up.

Next week, we promise a more detailed expose of Wall Street's flim flam. (Heck...the whole industry is down...now's the time to kick.)

Meanwhile, we go on...into the wild blue yonder.

And here we switch from the "innocent fraud" of Wall Street, as Galbraith calls it, to the armed robbery of government.

You see, the Obama Administration will have one overriding priority: to unblock the credit markets, put things back to "normal," and get the economy moving again. If he can do that - or even appear to do that (which is the only possibility) - Obama will go down in history as one of the nation's greatest presidents.

Of course, everyone is rooting for him. When times are good...we like horror movies and terrorist threats. But when they are bad, we want flicks with happy endings. Obama's election was a landmark for many reasons. But he won largely because voters wanted a "Hollywood ending" to the campaign. And now they want a Hollywood ending to the new national nightmare.

Will they get it?

Nah...but they might like the show anyway.

*** Dan Amoss offers his two cents:

"Those fearing deflation assume that every American consumer is stereotypical: an overextended, credit card-addicted, house-flipping gambler. This is simply not the case. Many Americans don't have a mortgage. And most Americans with mortgages are still making their payments. They have, however, temporarily reigned in discretionary spending because of falling house and stock prices.

"Those fearing deflation also assume that demand for debt is low and falling. But demand for debt doesn't always come from businesses or households looking to invest more or spend more. Any business or household looking to refinance existing debt at lower rates - and there are many - is a source of demand for new debt. Banks borrowing at the Fed window at 1% or less will be looking to supply this new debt by make highly profitable loans to creditworthy borrowers.

"Once borrowers refinance, they may not be as aggressive about spending or expanding business as they used to be. But at least they will have access to credit. In the Great Depression, they did not. So the economy fell into a negative feedback loop of asset sales, bank failures, and rising unemployment.

"Treasury and the Fed will keep taking extreme measures to slow down the pace of credit contraction and housing prices - cutting off this deflationary feedback loop. This could include nationalizing Fannie Mae and Freddie Mac and using the Treasury's low borrowing costs to refinance hundreds of billions in existing mortgage debt into new 40- or 50-year mortgages with reduced principal balances.

"Sure, such an action would guarantee a decade or more of stagnation in housing prices, but it will also slow or flatten the rapid decline in prices. This is the essence of the Treasury and Fed actions: to stop the deleveraging from getting out of control - even at the cost of future economic stagnation. Like it or not, I think this is the most likely outcome from this crisis."

***And now, let's look at what the Federal Reserve is doing...

As you'll recall, the main man at the Fed, Ben Bernanke, has spent almost his entire life studying what went wrong in the United States in the '30s and in Japan in the '90s. He's determined not to let it happen again - not on his watch.

And so, he's taking America's central bank where no central bank has ever gone before.

From the day of its founding in 1913, the Fed's assets - the foundation capital of the U.S. banking system - grew, reaching $1 trillion on the 24th of September, 2008. But then, something extraordinary happened. Something breathtaking. And for a classical economist - something incredibly reckless. In the next six weeks, the Fed added another trillion. And the head of the Dallas Branch of the Fed said that he expected to add another trillion before the end of the year.

How does the Fed get these "assets?" Simple. It buys them. Where does it get the money to buy them? Simple again: it creates it. It makes it up. It conjures it out of nothing.

"If it comes from nothing," you might wonder, "what could it really be worth?" But we're not going to answer that question. We don't have time. Besides, it takes us in such a deep metaphysical swamp, we're afraid we may never slosh our way out...or at least not get out in time for lunch. Instead, we're going to answer this question:

"If it was that easy, how come the Fed didn't do it before?"

The answer to that is simple: because when the Fed inflates the money supply it risks inflating consumer prices. People don't like that. They like it when asset prices go up. But not when gasoline and milk increase.

But now, no one is worried about consumer prices. In fact, the Fed is worried about deflation...about falling prices. Bernanke knows what happens when consumer prices begin to fall. Consumers stop spending - knowing that they will be able to get a better deal in the future. That further depresses the economy...and pretty soon it's the '90s again and you're back in Tokyo. So the Fed has begun a huge program of monetary inflation, intended to offset Mr. Market's price-cutting.

And now another question: Isn't there some risk that the Fed will overdo it?

Oh, dear reader...that's a puffball of a pitch. If we can't hit that, you can take our laptop away...you can break our sword...and send us back to the dugout.

Remember what happened in the slump of the early 2000s? Alan Greenspan panicked...cut rates to 1%...and left them there for more than a year. He gave the market the wrong medicine at the wrong time...and then delivered such a horse-sized dose, it set off the biggest bubble in mankind's whole bubbly history.

Now, it's a different kind of slump...a credit slump. And once again, the Fed is on the scene, like a quack doctor at the side of a heart-attack victim. This time, he's giving stronger medicine...not just a 1% lending rate, but actual monetary inflation. Trillions of dollars worth of it.

For the moment, Mr. Market is taking away dollars faster than the Bernanke Fed is replacing them. That could continue...for a few months...or even for several years. But it won't continue forever.

And here, we affirm our unshakeable faith in the people who lead us. They are trying to cause inflation. Eventually, they will get the hang of it. They may shoot for 2% per year; but they are sure to overshoot. Money printers always do.

Until tomorrow,

Bill Bonner
The Daily Reckoning Australia

• Federal Reserve Boosted Total Fed Credit
• Artificially Created Credit by the Federal Reserve System Got Us into This Crisis
• Biggest Bankruptcy in Wall Street History
• Funny Business at the Banks
• Bear Market to Last at Least Five Years

All around us is virgin territory. No one has ever been here before. But watch out, these virgins are vicious amazons. In this wild place, you can forget living it up. Don't even think about getting rich. Riches? If you've got 'em...hide 'em. Luxury? Who needs it anyway? The best you'll be able to do is survive. And then, maybe, years from now, we can put our financial lives back together again...and get on with things...

Never before have seen so much wealth disappear in such a short time. The latest report from MSCI shows the planet's losses from the sell-off of equities has now reached more than $30 trillion - or more than twice the GDP of the U.S.A.!

And this is just stocks. Reported write-downs, write-offs and credit losses have reached almost a trillion. And losses of housing prices in the United States alone - the only country for which we have reliable figures - has reached about $5 trillion.

Nor have we ever seen such a rapid reaction. In the space of a few months, people have gone from believing that nothing could go wrong to thinking that there's nothing that won't go wrong. Where once they thought that free-market capitalism would make them rich...they now believe that the government can save them from getting poor. And where only a year ago they thought the world's globalized economy would always give them everything they needed "just in time," they now believe they better keep a few sheckels on hand "just in case."

And just look at the bonds! A few months ago, investors stretched for yields. Now, it's safety they reach for. They dump corporate bonds for fear they may be "toxic," and grab U.S. Treasury debt with both hands. Investors now seem to have an unqualified trust in the full faith and credit of the world's largest debtor. Yields on 91-day T-bills have fallen to 0.11% - scarcely a tenth of one percent!

Yes, dear reader, the "Great Unwind"...the "Big Bust"...the "Great De-leveraging" - call it what you want; we've never seen anything like it.

The Dow rose 151 points yesterday - a limp and pathetic little attempt buck the downward trend. Gold lost $6.80...leaving it at $735.

China's stock market had managed an 18% rebound...following the announcement of its half-trillion dollar bailout plan. But yesterday, Chinese stocks were collapsing again.

The latest news from America tells us that housing prices are still going down in 4 out of 5 cities. Homebuilders' wives are hiding the shotguns and pouring out the whiskey; their husbands' confidence has never been lower, according to this morning's news report.

Big towns...little towns...in the sophisticated cities and out in bumpkin country, the story is the same. The Wall Street Journal tells us that the "fall in crop prices" is putting an end to the boom in the boonies.

U.S. producer prices fell 2.8% in October - the most they've ever fallen. And the Big Three automakers say that if they don't get some help soon, the results will be "catastrophic."

Meanwhile, over on the sunny California coast, the whole state is going up in smoke...it's not only going broke, it's burning up.

"I have to dust the ash off my car every morning," reports daughter Maria, recently arrived in LA and hoping to make it big in the motion pictures. "It's eerie...there's always a little smoke and soot in the air..."

Not only is the bust unlike anything we've ever seen before...so is the planet-wide effort to stop it. All over the globe, the feds are going 'into the wild' with extraordinary measures. They're mobilizing troops to fight the crisis in the boardrooms. They'll fight it in the stock markets. They'll fight it at home - with house-to-house combat to stop foreclosures and defaults. They'll fight it abroad - the U.S. government is even loaning money to foreign governments! They'll fight it with loans and giveaways. They'll fight it with fiscal policy. They'll fight it with monetary policy. They'll fight it with every weapon available to them - including the printing press.

And they will lose.

*** To give you an idea of the wild measures undertaken by the feds, we look at what is happening at the world's leading bank - the U.S. Federal Reserve.

The short form of how the Fed operates is this: it holds a certain amount of securities in its vault; this is the cornerstone capital - or monetary base - of the whole banking structure. How does it get this capital? It buys it, creating the money to pay for it as necessary. Naturally, the Fed doesn't want to create too much money or the inflation rate would get out of control and economists would point their fingers accusingly. But now, people fear dandruff more than inflation. So, the Fed has gone wild.

From the day of its founding in 1913 to September 24, 2008 the Fed's assets - the aforementioned cornerstone capital for the US financial system - grew to $1 trillion. By November 14, 2008 the amount had grown to over $2 trillion. And in a speech in Texas, the head of the Dallas branch of the Fed said he expected the total to reach $3 trillion by year-end.

For the moment, this explosion of monetary inflation is hardly noticed. Asset deflation has the headlines. People worry about having too few dollars, not about having too many.

Comes the news this morning that U.S. business chiefs are asking the up-coming Obama administration for another $500 billion 'stimulus' program. They'll get it. And much more. Trillions worth.

Trying to stimulate the economy with easier credit in the early 2000s, Alan Greenspan overdid it. He gave the world the credit it wanted, and created the biggest bubble in human history.

Now that bubble is collapsing and his successor - Ben Bernanke - is confronted with a new problem. Now it is cash that people want - income to pay their debts! Bernanke will give them what they want. And, most likely, he will overdo it too.

*** At a recent hearing on Treasury Department use of government assistance funds, Ron Paul, who is well-known for often calling out the Federal Reserve chairman on their liberal use of the printing press, took on Big Ben. Here is the transcript of their interaction, in case you missed the C-SPAN coverage:

Ron Paul: The Austrian free market economists had predicted all these problems would come, and they were certainly correct in everything that they said. Of course they're not very satisfied including myself with the so-called solutions, because it looks like we're spending a lot of energy and a lot of money trying to patch a system together that is unworkable.

So we have Congress spending a lot of money, we have Treasury very much involved in trying to pick and choose which worthless asset that we're going to buy, and of course the Federal Reserve is involved in injecting trillions of dollars that nobody seems to be keeping track of.

But what we're failing to do I think is to recognize that the system no longer works, but I can understand why we do this because if Congress couldn't do this and if the Fed couldn't do this and Treasury couldn't do this, it would make us all irrelevant. And instead of looking at the causes of this, and then finding the solutions aren't going to be found here, we have to make ourselves feel pretty important.

But I think there's another reason we think we're pretty important, it's because in a way our interference in the market corrections that tried to come about since 1971 seem to work. I mean, the failure was established in 1971 with a system that had no way of automatically correcting the balance of payment and the current account deficits.

And that's where the problems have been, and economists - whether they were left or right or middle - over the last several decades have always said, this current account deficit is a big problem. And now it's totally out of hand. So here we are struggling with all these rules and shifting back and forth and really getting nowhere.

My question is directed toward, when we come to the full realization that the system is unworkable, what are we going to do, what have you thought about doing, and already we see talk in the newspapers. We see articles about a new international world reserve currency, and to me that's pretty important, because the fiat dollar reserve system is not going to work anymore, and that's the information that we have to accept and decide what we're going to do in the future.

Also, this is not new in history. Currencies have failed, financial systems have failed, and generally, to restore the confidence that everybody is talking about, they usually have to go back to a currency with integrity to it, rather than just fiat money.

And, you know, the stages is there. It's not impossible, already the central banks of the world still own 15% of all the gold that was ever mined in all of history. So they hold on to this gold for some reason, and therefore something has to give, or are we going to keep trying to waste more money and time patching this system together.

Just last week there was a report that Iran purchased 75 billion dollars worth of gold, took their reserves out of Europe, bought gold and put it in Asia. So is that a sign of the times, is that moving on?

My question is, in your meetings, and you had a meeting just recently with other central bankers, does this thought come up about a new international world reserve currency, and if so, does the subject of gold ever come up?

How do you restore the confidence? Have you recently had conversations with any central banker, and is there a move on to replace the dollar system, because the dollar system is essentially declared dead, because it's not working, but this indeed was predictable because of these tremendous imbalances that were never allowed to be corrected, and they were always patched up. We always came in. We'd spend, we'd inflate, we would run up deficits, and since '71 we've been able to correct these problems.

Could you tell me what kind of conversations you've had regarding a new reserve currency?

Ben Bernanke: Yes, Congressman. I don't think the dollar system is dead. I think the dollar remains the premier international currency. We've seen a good deal of appreciation in the dollar recently during the crisis precisely because there's been a lot of interest in the safe haven and the liquidity of dollar markets.

And the Federal Reserve has been engaged in swap agreements to make sure there's enough dollar liquidity in other countries because the need for dollars is so strong. So I think the dollar system remains quite strong.

I do agree with you very much on one point, which is about the current accounts. The current account imbalances have proved to a very serious problem. It was in fact the large capital inflows in those current accounts which created a lot of the financial imbalances we saw and have led to some of the problems we are seeing, and one of the silver linings in this huge grey cloud is that we're seeing some improvement and greater balance in our current account deficits.

Ron Paul: But does the subject of a new regime ever come up?

Ben Bernanke: No, it doesn't.

Ron Paul: And does the subject of gold ever come up in any of your conversations?

Ben Bernanke: Only in terms of the sales that the central banks are planning.

The I.O.U.S.A. team interviewed the Congressman for the documentary. If you didn't have a chance to see the film when it was in theaters, now's your chance. We are offering an exclusive package to long time DR sufferers: you can get the DVD (before it is released to the general public), the companion book and your own personal bailout package. Don't let this opportunity pass you by...quantities are limited, and are going fast.

*** GWB - you can't say we didn't warn you. A top British judge has just announced that he considers the Bush administration's attack on Iraq as a violation of international law. Years from now, George W. Bush is likely to be charged with war crimes and human rights violations. Normally, this would pose no problem. A former U.S. president could expect the protection of the U.S. government. But as Americans sink into depression they are not likely to feel kindly towards their ex-president. They will blame him for the decline of their incomes...and for the fall of their empire. They are likely to want to cooperate with the world's new institutions...and throw over their own former commander-in-chief.

Advice to GWB: Go back to Texas. Don't ever leave home again.

*** Colleague Patrick Cox, at Breakthrough Technology Alert offers some rare optimism into this otherwise downright gloomy market:

"Yes, we have been swindled by politicians who pushed the U.S. banking system into the shape it's in today. The people who tried to stop the meltdown have utterly failed to explain the root of the problem to the American people. We've officially entered recession now and policymakers will do little to address the real problems.

"Though the hit the economy has suffered recently pales in comparison with the drain on world resources associated with that war, our situation is similar. We are at a point of incredible opportunities.

"The reason is, in a word, science. The accelerating pace of breakthrough discoveries will deliver economic benefits that few fathom today. While the entire world will gain from these discoveries, investors who understand what we are going through now will profit most and earliest. Even better, the return on these stocks will be so great that even relatively modest investments will produce fortunes.

"Let me give you a few hints about the shape of things to come. Just in the last few weeks, two groups of scientists announced the discovery of microorganisms that produce biodiesel naturally. Professor Gary Strobel from Montana State University discovered a fungus deep in the Patagonian rain forests of Argentina. This organism naturally produces the long chain hydrocarbons needed to create fuels.

"Even bigger news is coming on the medical front. I predict that real stem cell therapies will be offered offshore within the year. Currently, there is a billion-dollar industry offering stem cell snake oil, but real lifesaving and life-extending therapies are already available in the laboratory. These therapies are relatively inexpensive to produce and will revolutionize medicine. Even the FDA will come around when wealthy early adopters begin reporting true rejuvenation results. By the end of Obama's first term, we will see SC and other therapies that will radically cut the cost of treating horrendously expensive illnesses."

Patrick has been alerting us to a breakthrough that could change the way we view modern medicine. And when news breaks - which is rumored to happen tonight - those who have gotten in on this revolutionary idea stand to make some pretty major gains.

*** We got a letter from Her Majesty's government.

"Winter Fuel Payments...don't miss out!"

Yes, dear reader, this is how societies collapse. People invent problems. Then, they find solutions to the problems. Then, the solutions cause more problems. And finally the cost of all the solutions brings the whole system falling down.

A news report out today tells us that the weekend will be cold. An "arctic blast" is said to be on its way.

Of course, some parts of the city already feel as though they were in a nuclear winter. London's main industry is finance. And finance has iced up. A headline in yesterday's paper told us that London is expected to lose 370,000 jobs over the next two years.

But thank God for the world improvers:

"Our records show that you may become eligible for a payment this winter," begins the letter.

Why? Because your editor is enrolled in the Britain's national health service (a requirement for employment). NHS records must have revealed to the authorities that your editor turned 60 in September. Accordingly, he is eligible for 125 pounds to help him with his heating costs this winter.

Imagine the miserable bureaucrats administering this program. They have computers to program...letters to write...records to keep...internal procedures to devise, administer and respect. They have to hire people...and then support them for the rest of their lives, paying for pensions and holiday, just like any other business. Then, they have to work out internal disputes...make sure the coffee maker is working properly...and organize an annual Christmas party. It probably costs more than 125 pounds to send out each check!

And why should someone over 60 get money and not someone under 30? The older person has had 30 more years to stuff newspaper in the cracks, firewood in his garage and money in his bank account. If he's cold this winter...it's his own damn fault.

But if you're going to give him money to help him keep warm, why not some extra money to help him with his eating needs? He has to eat, doesn't he? And why doesn't HM Government just send him a bottle of Chateau Margaux? Maybe 1985. To help him with his drinking needs.

Until tomorrow,

Bill Bonner
The Daily Reckoning Australia

• Oil Prices Decline but Consumers Aren’t Out of the Woods Yet
• Dealing with Future Economic Problems Today
• Housing Market Drops Housing Prices by 16%
• The Feds Are Counting on Fannie and Freddie to End the Nation’s Housing Misery
• The Deficit is Expected to Reach Beyond $500 Billion

USA Today says, "Americans are digging to save money." They're digging into their budgets... exhuming every expense they can. And they're digging into their attics too - selling "stuff" they no longer need.

Most people say they are cutting back on restaurants, travel, and luxuries, the paper reports. Instead, they're staying at home and renting movies for entertainment.

Here in London, we went out to a restaurant last night and found it almost empty. "Where are the customers?" we asked the waiter, thinking we were too early. "Oh... it's this financial mess... nobody wants to come out to a restaurant any more."

eBay says the average family has about $3,200 worth of stuff it doesn't need. People are getting it out... cleaning it up... and shipping it off. In return, they get what they need - cash.

Readers with a weakness for economics will see in both of these examples a dismal herald. They announce a collapse of consumer demand. Not only are people spending less... but even when they do shop, they're buying more second hand stuff... stuff that comes from closets and attics - not from China.

So what? Well... if they're not buying new stuff there's no need to make new stuff... or sell new stuff...

"Fewer spots on the sales floor," this Christmas season, announced one headline. Fewer spots on the assembly line too. And fewer paying spots anywhere.

And if nobody wants to buy new stuff, the companies that make and sell new stuff are going to be in a world of hurt. Which is why the stock market is collapsing. The Dow fell another 223 points yesterday.

Oil fell yesterday too - down below $55. If you're not making stuff, you don't need so much energy to make it and ship it... And if you're not buying stuff, you don't need so much gasoline to get to the mall.

Oh! Bama! Where is thy bounce! We're getting tired of waiting.

But hold on... settle down... relax. Breathe deeply. Take it easy.

After demand collapses, supply collapses. Yes, dear reader, it's all part of Nature's plan. In the beginning, there is The Bubble. Then, the bubble pops. Then, people look around and take fright. They realize they've got to stop spending. So, demand collapses. Then, stocks collapse too. And asset prices fall too - especially for speculative assets. As orders and asset prices tumble... merchants and manufacturers cut back too. Jobs are lost. And then, with less income... demand collapses some more.

But then, eventually, the bubble is completely flattened. Weak companies have gone out of business. Good companies are holding on, but producing less. Many retail shops have closed. Many malls have gone out of business. Supplies of goods and services have fallen as far as they're going to fall. Then, with supplies tight, prices begin to rise again.

The whole process takes time. There are millions of mistakes in need of correction. Each one has to be marked down, written off, worked out, and forgotten. We still have to see the show trials. And the perp walks. And the kvetching... the complaining... the whining... the wimpering. The bailouts and the payoffs... The bottles of whiskey and the loaded revolvers. It's all still ahead!

Dow 5,000...

10% - 15% unemployment...

Another 20% off house prices...

There's a lot of ruin left to go...

*** Sunday afternoon, we sat down in the large leather chair in front of the fire. Its arms were shiny and worn... much lighter in color than the rest of the brown chair.

Immediately, we felt wiser. Then, a blindingly bright flash of insight seem to come out of nowhere. Suddenly, we saw into the dark heart of the beast itself - and peered into its soul. And then, we watched in horror. In our mind's eye we saw images of recession... depression... despair... desperation... and finally upheaval... in which the whole system... the world's dollar-based money system... came crashing down.

Yes, dear reader. We are a proud heir to Dr. Kurt Richebächer. Not of his weighty intellectual career in economics. We are heir to his chair. After he died, his estate sold us his chair. We keep the Dr. Kurt Richebächer chair in our library. Sitting in it this weekend, we thought we saw the whole financial crisis more clearly.

"The only cure for a bubble is to prevent it from developing." said Kurt Richebächer.

In other words, you can't cure a bubble by cutting interest rates, easing bank lending requirements, running bigger government deficits, sending out 'rebate' checks, buying up Wall Street's stupid mistakes, or bailing out sinking businesses. You can't cure a bubble by reflating it. You can't cure a bubble at all. You have to let it pop... and then go about your business. Get it over with quickly; that's the best you can do.

Think that will happen? Where have you been, dear reader? Out of Blackberry range?

No, the feds are at work - with their patches, their rescues, their bamboozles and their swindles.

In our brief moment of clarity, induced by the Richebächer chair, we saw what was coming - the biggest financial bailout of history. It will be like WWII, without Betty Grable... like the New Deal without the wheelchair - and like nothing we've ever seen.

Saving America from free-market capitalism will become the Great National Project of the Obama years. Deficits will top $1 trillion... maybe $2 trillion. Brain dead businesses will be kept alive. Whole industries that should be allowed to go broke will be protected. Towns, states, and colleges that should go bust will be propped up. There will also be a huge building boom - in infrastructure. Bridges, trains, highways...

... it may be time to buy cement companies!

The bailouts are just money down the drain. As for the bridges, who knows whether they are worth the money? But this massive program will achieve its real purpose - distracting and diverting Americans from their loss of wealth.

*** If Olympic medals were given for consumer spending, Americans would have won the gold, silver and bronze every year for the last 20. But now, Americans may become champion savers. Savings could rise to maybe 10% of GDP.

What will happen to all this money? It will be lent to the government. (About which... we will have more to say tomorrow.)

So do you see, dear reader, how the new financial system will work? Instead of squandering their money - as Americans have done for the last 20 years - now, the government will squander it for them.

*** Here comes the Era of Conspicuous Thrift. Yes, you heard it here first.

"No more fancy pants," is a headline at the New York Times. The gist of the accompanying article is that even expensive restaurants are now trying to look cheap. People who still have money to spend don't want to spend it... and when they do spend it, they don't want to look like they are spending it. So restaurants are putting on de po' bo'... that is, they're acting poor. Gone are the sumptuous drapes... gone are the plush carpets and marble tables... gone are the fancy pant waiters.

"Luxury is a dirty word," said one of the designers.

Don't get us wrong. People always look for ways to feel superior to their fellows. In the bubble years, they did so by spending wildly... trying to outdo each other with the extravagance of their purchases and the sans soucis of their budgeting. Young Wall Street pros... or rap musicians... would go out to a fancy restaurant and order a big bottle of Cristal - just to show off.

But styles change. Now, people are showing off by NOT spending money. Sound unbelievable? Well, maybe. But our guess is that people are going to find more subtle... and less expensive... ways to wink at each other. Heavy spending is going the way of heavy drinking. It will be seen as vulgar.

*** And today, we add to our short list of the world's greatest inventions. So far, we have only three inventions that have been unequivocally great boons to mankind - crispy duck (as it is prepared here in London's China Town)... the beret... and the semi-colon. All three are such marvelous innovations that they seem to be almost divinely inspired.

Today, we add one more - the bicycle. Despite the skinned knees and broken necks, the bicycle has done more for mankind than any other transportation device. In fact, we feel we must apologize to the bicycle for not adding it to our list sooner. Millions and millions of people depend on the bicycle to get around. Millions more may soon take it up...

• Millions of Zimbabweans Face Starvation due to Nationalisation caused by Hyperinflation
• Why Those Who Praise Capitalism Have So Little faith in It
• Why the Oil Price Will Correct Itself
• Commodity Inflation Causes Consumers to Cut Back on Spending
• A Consumer Economy Doesn’t Work

Before we do, let's look at the headlines.

The Dow dropped another 338 points on Friday... and lost another 2 % early this morning. How much more of this can investors take? Berkshire Hathaway fell below $100,000. And GM appeared to be heading for the junkyard.

A GM bailout would cost $200 billion, say the papers. Uh oh... that's more than the feds have on hand. And right behind GM are cities, states, colleges... all with their hands out...

Yes, they are all of "vital national importance." We can't let them fail, can we?

Of course, it's all nonsense. Automakers... governments... they go broke from time to time; it's no big deal. And colleges... who needs them? You can get a much better education just keeping your eyes open. Right now, Mr. Market's Advanced Seminar on Economic Corrections is delivering one helluva lesson. Of course, the tuition is very expensive...

Stocks are down so much that dividend yields are beginning to look respectable again - averaging about 3.8%. For the first time in 50 years, you can get more yield from a stock than from a 10-year US Treasury bond. You remember, stocks were supposed to pay lower dividends because stockholders are supposed to earn capital gains as well as dividends. The combination of capital gains and dividends gives investors a total return greater than bonds; this is the "risk premium" that you get to compensate you for periods when stocks go down. What happened to the risk premium? Here it is!

When is the risk premium at its lowest? At the very moment when investors believe it is highest. That is, at the end of the '90s, investors came to believe that they couldn't go wrong with stocks. They were so sure that stocks were the way to go that they willingly bought stocks that paid little or nothing in dividends. They thought the price of the stock would go up; so they didn't need dividends.

But stocks have gone nowhere since the mid-'90s. Now, investors want dividends.

Meanwhile, to those who have been given the most Mr. Market takes the most back. No country got as much out of the credit expansion as Britain. Its leading industry - finance - was in high cotton for the last decade. Gone were the conservatives old bankers with their derby hats and pin striped suits. The new breed of go-go moneymen in the City wore fancy Italian suits and came up with plenty of fancy investments too.

But just as the bankers were fashion victims, so were their clients.

Poor RAB Capital, for example. The hedge fund manager is traded in London. It's seen its funds under management fall by 70%... and its share price is down 92%.

The pound is down 25% against the dollar over the last 90 days. Housing is down about as much as in the United States. "Help wanted," signs are disappearing from shop windows. And suddenly you can get a table at a good restaurant without a reservation.

But that's the trouble with a downturn. Just when other people can't afford to eat at fancy restaurants - neither can you!

"Everybody's got to cut back," we told the family again on Saturday. "This is a global financial crisis. We don't know how long it will last or how bad it will get. But we're saving every possible penny - just in case."

This is what economists call the "propensity to save." It's what happens in a serious downturn. But the propensity to save is not necessary shared by all the members of the family alike. Edward, 15, put his finger on what economists call the "paradox of saving:"

"Hey, Dad, but if we all stop spending... nobody will have any money, will they? Besides, you said you'd get me a new skateboard for my birthday."

Edward is more civic minded than his father.

High rates of saving causes a recession to turn exceptionally nasty. People cut back... and all of a sudden... the cutbacks are magnified by millions of little decisions all up and down the economic ladder. The rich cancel their restaurant reservations... the poor buy a little less meat. But one man's expense is another's revenue. Pretty soon, money is getting tight throughout the whole system. That said, the man whose financial advisor tells him to keep spending in order to help the economy has a fool for a counselor. The smart thing to do is to cut back; let someone else go broke.

*** We are so happy to see Thomas L. Friedman back in the pages of the International Herald Tribune... and back in form too!

The NY Times columnist is always entertaining... and helpful. Unwittingly, of course, the only way possible for Friedman. What makes him entertaining is that he is perpetually in a state of emergency... an irrepressible alarm... that causes him to run around wildly and crash into things.

Remember the terrorism scare of the early 2000s? Friedman was right at the front of it... howling at the mob to mobilize... urging them to panic. Otherwise, the terrorists were going to blow up every public building and underwear store in Christendom. More recently, there was his fright about rising oil prices. Once again, we had to "do something!" He called for a massive, nationwide campaign, "similar to the Manhattan project," in order to save America from the oil exporters.

Now, it's the financial crisis that has the man in a sweat. What a delight to have his views on the financial world! He is such a shallow thinker that his errors are always right on the surface. It is reassuring too; if Freidman agreed with our position, we'd have to rethink it.

"If you are going to fight a global financial panic like this, you have to go at it with overwhelming force," writes Freidman. How does he know that? How many of these things has he seen? Well, none. No one ever has... which he admits a few lines earlier.

But ignorance never stops Freidman. He may not know where the enemy is... but he gives the order anyway: "Charge!"

"This is no time for half-measures," he continues. How does he know what is a half-measure and what is a full measure? And what about no measure at all? Again, he doesn't explain. But this is no time for thinking - it's once again, into the breach! What we need now is "an overwhelming stimulus that gets people shopping again. And an over-whelming recapitalization of the banking system that gets it lending again."

"Go shopping," he summarizes.

Anyone with half a brain knows that it was too much shopping and too much lending that got the United States into this jamb. But that disqualifies Friedman right there. Not that he isn't a smart fellow; but he's determined not to let thinking get in his way. He's smart enough to know that once you start thinking about things, they always turn out to be more complicated and nuanced than you had hoped.

But if you concern yourself only with appearances, you don't have to worry about it. What do people in a healthy economy do? They go shopping. What do banks in a healthy economy do? They lend money. So, hey, this is easy. If banks would just lend and consumers would just buy things - we'd have a healthy economy, no?

Another charming feature of Friedman's pensée is his willingness to chuck principles, rules and dignity whenever they get in the way. Dismissing the question of why the taxpayer should pay for Wall Street's mistakes, he writes: "... fairness is not on the menu anymore... we need to throw everything we can at this problem... "

And now we turn our attention to the White House. George W. Bush is said to be not merely a lame duck president... but a dead duck too. He cost Republicans a victory, say pundits: he ruined the country... he destroyed the empire... he wrecked the economy. Today, you could accuse the man of sorcery or child molesting and half the nation would believe you.

Before we come to our revisionist look at the man, we repeat our advice. Just this weekend, Barack Obama pledged to put an end to Bush's disgraceful torture policy. Dubya should watch his back and avoid foreign travel; otherwise he's likely to arrested and slapped with a human rights violation. After all, most of the world would like to see him do the perp walk. Besides, he deserves it.

But here at The Daily Reckoning we always take the side of the underdog and the lost cause. Poor George is both. So, when we read the text of his speech last week in New York, we found it to our liking. Here is a man who has had some sort of brain operation or brain washing, we decided. They severed the connections, making it possible for him to think one thing and so something entirely different.

"History has shown that the great threat to economic prosperity is not too little government involvement in the market. It is too much government involvement in the market. ... And the surest path to... growth is free markets and free people.

"Capitalism is not perfect. But it is by far the most efficient and just way of structuring an economy. Capitalism offers people the freedom to choose where they work and what they do, the opportunity to buy or sell products they want and the dignity that comes form profiting from their talent and hard work...

"The record is unmistakable: if you seek economic growth, social justice and human dignity, the free market system is the way to go."

These insights are, to our mind, correct. But the U.S. government with George W. Bush at the controls hardly favored free-market capitalism. Instead, the Bush administration presided over a "mixed economy" - both "innocent fraud," as John K. Galbraith described the free-market's excesses, and the government's armed robbery.

... 36% of GDP was spent by government... and more than half of all eligible voters depended for their livelihoods - in whole or part - on government checks

... federally-chartered mortgage lenders - Fannie and Freddie - helped stimulate a huge bubble in the housing market

... the US government's central bank - the Federal Reserve - led by Mr. Bush's appointee, Alan Greenspan, practically single-handedly caused a huge bubble in finance, credit, speculation and consumer spending

... when the bubble inevitably burst, Mr. Bush's own Treasury Secretary (recently one of the Wall Street bankers who had most benefited from the financial bubble) rushed in to use government money (aka taxpayers' money) to buy up Wall Street's mistakes...

... then, the feds partially nationalized the nations leading banks...

... and further lowered the cost of credit, in order to try to blow the bubble up again...

... and now, the United States, along with the world's other leading governments, is pledging to give the world what it least needs - more regulation!

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And yet, now we have the water rising all over the world... and whole towns in California already submerged. Where are the plumbers?

Who knows? Maybe they had something to do with yesterday's rally. The Dow rose 552 points. The dollar went down hard - with the euro up to $1.28. And gold rallied $16 too - to $734.

The feds are doing all they can to bail out the economy. If they wanted, they could give the stock market a little boost from time to time. But probably not much more than that - and a great cost. And for all their bailing, the water is still rising...

Foreclosures are increasing at a 25% rate. GM is on the verge of bankruptcy; it's stopped talks with Chrysler. Joblessness is at a five-year high - and rising.

But there is good news too - prices dropped 65% at a wine auction... White truffles are down 84%.

This just in from colleague Ingrid Labuzan at MoneyWeek:

"In England, the housing slump is catching up to the U.S. Prices are officially down 14.6%. The average U.K. homeowner is losing money faster than he makes it. The housing bear market is reducing house prices by about 27,000 pounds per year - while the average bloke earns only 24,000. And every day, 121 houses are repossessed.

"The unemployment lines are getting longer too. There are expected to be 2 million people in Britain without jobs by the end of this year. Next year, the number is supposed to reach 3 million, above 10% of the workforce."

The OECD, meanwhile, says the floodwaters are rising all over the world. They expect the soggiest year in a long time... with negative growth in the developed world in 2009. Germany says it already faces the worst recession in 12 years.

For us, here at The Daily Reckoning, the crisis comes as no surprise. Heck, we saw it coming years ago. Of course, even we didn't think it would hit so hard... and so wide. We thought Japan, for example, would be spared. The poor Japanese are already black and blue from having been beaten up for the last 18 years; we figured they'd had enough. Instead, the Tokyo stock exchange got whacked again - taking stock prices down to levels last seen in 1986.

India, too, we thought would stay out of it. After all, Indians are pretty sober people. Almost party poopers. But the same stiff, moronic regulations that kept India from participating in the global credit expansion also meant that India's banks and consumers were less exposed to the global credit contraction. No party; no hangover. Still, that didn't stop investors from selling Indian stocks along with everything else.

We're surprised at how violently the downturn hit commodities too. Rightly or wrongly, investors are expecting a long, deep, deflationary correction.

"We are all Japan, now," says Albert Edwards at Societe Generale.

Of course, we know how it works: the correction must be equal and opposite to the shenanigans that preceded it. But which shenanigans? What, exactly, is this correction going to correct?

So far, the financial industry and the housing industry have had their fannies paddled. Just as you'd expect. They deserve it. Go ahead, Mr. Market, let 'em have it!

The U.S. auto industry too deserves a good spanking. It failed to hold down costs and continued making inefficient, gas-guzzling vehicles long after the market had turned away from them. It should be allowed to fail. Get it over with. Make room for new blood. There are a lot of automakers in the world; we don't need these dinosaurs.

America's retailers... and shopping malls... and fast-food joints... Well, the list of industries in need of a good whack is long and obvious.

But right now, it's the consumer who's bending over. In fact, from MarketWatch we get the news that "retail sales plunge a record 2.8% in October."

*** "Consumers stop shopping," is the stark headline at the Chicago Tribune. We know that that is just what he should do. He's got to pull himself together, get on the wagon, clean up his balance sheet.

But here come the feds - determined to stop him. They pull up to his house in a shiny convertible. "C'mon... it's happy hour all night long... No money? Don't worry, I'll lend you some... "

Here's the report from the New York Times:

"... with a little more than two months left before President Bush leaves office, Treasury Secretary Henry M. Paulson Jr. is hoping to put in place a major new lending program that would be run by the Federal Reserve and aimed at unlocking the frozen consumer credit market.

"The program, still in the planning stages, would for the first time use bailout funds specifically to help consumers instead of banks, savings and loans and Wall Street firms.

"Treasury officials said they hoped to invest about $50 billion from the bailout fund into the new loan facility, with the aim of helping companies that issue credit cards, make student loans and finance car purchases."

Paulson's new plan is simple enough. Borrow money from savers all over the world and give it to spenders in the United States of America. Put things back to 'normal' - or at least to what they were a few years ago. To a thinking man, of course, this plan is absurd. It merely encourages Americans to continue making the same mistake - spending money they don't have on things they don't need. Rather than cleaning up their balance sheets, they'd be making them worse.

But you couldn't put together a chess team with the few people who have their thinking caps on. This is a crisis; everybody says so. And in a crisis, you don't stop to think - you act! You act like a jackass, usually.

Paulson was the front man at Goldman up until 2006. You'll recall that that was when Wall Street's party was completely out of control... when financial shenanigans reached their crazy apogee. Now, the very same Henry Paulson is working his magic on the whole U.S. economy - good luck to us all!

But it really depends on how much correction Mr. Market has in mind. Is he correcting the excesses of the 2002-2007 period? That would take the Dow back to 7,000 or so... and cut housing down a few more percentage points.

But it would leave the fundamentals of the economy intact. Or is he correcting excesses of the entire bull market from 1982-2007? Or is he aiming to correct the whole, grotesque dollar-based post-'71 money system? That is, is he merely trying to correct the bubble or the pump? The speculative hyperbole of the last 5 years... or the source of so many bubbles... and so much economic distortion - the paper money system created by Richard Nixon in 1971?

We don't know. But judging by the way things are going... our guess is that he has bigger fish to fry than just the stock market... or the housing market. This looks like the big one to us - the "Greater Depression," as our old friend Doug Casey puts it.

Our guess is that he aims to take America down a peg or two. Its money. Its standard of living. Its power and its prestige. It won't be pleasant for many Americans... but in the end, they will be standing on more solid ground.

*** Chris Mayer assures us that there are still some companies that are doing well...

"By and large, at Mayer's Special Situations, it seems we've been successful in finding the little creases and pockets where companies are still doing well and reporting strong results. The stock market, though, isn't giving them much credit. At some point, the market will change. Investors in companies like this will get their reward in a better multiple and a much higher stock price.

"In the meantime, we can only watch our companies grow their businesses and execute fundamentally. The price will catch up eventually. But the wide discounts give us plenty of chances to build low-cost positions in a number of exciting opportunities."

Chris' latest alert has more than a few exciting opportunities for you, dear reader. Check them out here.

*** This from colleague Dan Denning in Australia:

"I ran across Dmitry Orlov's book, Reinventing Collapse, in which he compares present day America to Soviet Russia prior to its... collapse."

"Orlov outlines five stages of collapse, and where the U.S. along the way:

"Financial Collapse. Already in motion."

"Commercial Collapse. Just started."

"Political Collapse (a loss of faith in ideology). First part is over (the recent election in the US). Second part is going to be nasty."

"Social Collapse. Potentially the end state or stable equilibrium point for most of the world. Everyone against everyone with points awarded by the global marketplace."

"Cultural Collapse. Full meltdown. Global market breaks."

*** Finally comes word that "VP-elect Biden aims to be a hands-on No. 2." What a disturbing thought. When an empty car drives up to the White House for a meeting with Obama, it will be Joe Biden who gets out.

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At least a McCain victory would have caused the press to hold its tongue. Instead, commentators drew all the wrong conclusions and made fools of themselves. Some thought it meant America's redemption from the sin of slave trade. Others saw a historic transformation that they couldn't put in words and shouldn't have tried.

"They did it. They really did it," wrote the Guardian. "... the American people yesterday stood in the eye of history and made an emphatic choice for change... "

It's the "End of the National Nightmare," said TIME magazine.

Amid the effervescence came the French. Obama's victory "arouses a wild yet reasonable hope," claimed Bernard-Henri Levi in the Financial Times. Mr. Obama's election will affect us in "at least three concrete ways," he continued... a decisive turning point in dealing with the 'racial question' in the US... hope for an America that began doubting its "famous mission"... and with Obama representing the USA, "anti-Americanism... will have a harder time surviving and it will be forced to revisit its sales pitch."

Nobody knows what America's "famous mission" is - certainly not the Americans themselves. And if those are his 'concrete' ways, we're glad Mr. Levi is not building bridges. There was nothing concrete about the hopes Mr. Obama's victory arouse. Just the contrary... they are all in the ether.

They shouldn't let French philosophers comment on American politics; they take the whole thing far too seriously. Besides, you never know what they are talking about anyway. But Le Monde saw it clearer. Not only was the paper happy to see the United States finally rinse the stain of racism out of the Stars and Stripes, it was glad to see Americans give free market capitalism the flush too.

Obama will be "reviving the role of regulation in the U.S.; [devising] tax policies to smooth out increasingly wide socio-economic divides; planning a health-care system appropriate to the country's wealth," said the paper. In other words, he will be putting in a system of state-directed capitalism, just like they have in France.

None of the commentators we read really understood Obama's triumph. They saw it in a yearning for truth and a stretch for progress. It was nothing of the sort. The last thing voters want is the truth; they will reject it if it is put in front of them. Instead, what they want is diversion from the real world. What they hope to get from their leaders is a kind of entertainment... in short, a fantasy. Something to cheer them up when they are down. Or something to give them a fright when they are up.

You'll recall from last week, the last period of Great Calamity - 1914-1945, with its wars, epidemics, Dust Bowls, hyperinflation, Great Depression, mass murders, bankruptcy and revolutions. It was in the middle of this period that Americans elected Franklin Roosevelt, who told them they had "nothing to fear but fear itself." It was all in their heads! It was a whopper, but it was the whopper they wanted to hear.

And then, on right side of the Atlantic, Britain chose Winston Churchill as prime minister, in May 1940. Churchill crossed his fingers and put his hand behind his back immediately, claiming that Britain was not fighting to save its overseas empire, but to "save the whole world." He promptly kicked out any official who was "exercising a disturbing or depressing influence," that is, any who dared to tell the truth about Britain's disastrous military situation.

Just weeks later - in France, after suffering the most humiliating defeat in their history, the French recalled an old man to power, Philippe Petain. The hero of Verdun made the French feel that they had just regained their national glory, not just lost it. But at the time, France's fantasy seemed on more solid ground than Britain's... which just goes to show how unreliable history can be. Sometime make-believe becomes real; usually, it doesn't. Britain got the backing of the Roosevelt administration - which had promised voters to keep America out of the war - and beat the huns; Churchill died a hero. Petain died in disgrace.

Today, in the U.S.A., the Bush Administration has worked hard to make people fearful - with its torture chambers and preposterous "threat levels." But the terrorists wouldn't cooperate; they failed to blow up even a trash truck. Alas, now the mob sweats - and for good reason. People are afraid of losing their houses, their jobs, and their retirements. Losses in equities worldwide top $25 trillion. In U.S. housing alone, some $4 trillion has disappeared. That's why Obama won; it has nothing to do with national redemption or Sarah Palin. When the world was safe and plush... the mob wanted to feel the frisson of danger. What the public wants now is safety: a movie with a happy ending, not a horror flick. Obama appeared the calmer, more intelligent, candidate. Voters could imagine him as the "black Roosevelt" giving soothing fireside chats and telling the lies they most wanted to hear.

And so, in the national narrative, one cockamamie bamboozle takes the place of the one that went before. Americans were supposed to be fearful; now they are supposed to be confident. They were supposed to be racists; now they are supposed to colorblind. They were supposed to defend free market capitalism to their last breath; now they turn to the state and beg it to protect their last dime.

Bill Bonner

For The Daily Reckoning Australia

Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

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Oil fell to $56 a barrel; investors feared that the world's drivers would leave their cars in the garage and the world's teenagers would begin turning off the lights when they left their rooms.

And they seem to be right.

"Buying binge slams to a halt," reports the New York Times. It is a "crisis of confidence" among consumers, the paper explains.

Crisis of confidence? No... it is more like an attack of good sense... a bout of sanity... a brush with sobriety. This is a 'balance sheet recession,' remember. Consumers, businesses and speculators are all acting perfectly reasonably. They haven't lost their senses, in other words, they've come back to them. They finally realize that they need cash... savings... money in the bank "for a rainy day."

The weather forecasters on Wall Street and in the press said it would never rain again. But here it is - pouring down!

Even gold is running for shelter. The price of an ounce of gold fell $22 yesterday.

A hard rain is gonna fall. No doubt about it, it's falling already.

And now, the whole world turns its weary eyes to America's president-elect - Barack Hussein Obama:

"Mr. Obama, please... do something!" they beg. "Save me! Spare me! I promise I will never do stupid things with my money again. "

Will Obama be able to restore consumers' confidence? Will consumers recover from their bout of sobriety? Will the feds be able to lure them off the wagon with more cheap booze?

And so... those questions before us... the world moves closer to its first trillion-dollar deficit. Wait... did we say 'trillion dollar?' Make that $2 trillion.

There is now no doubt about the general direction of the markets and the economy - they're going down. That's not to say we can't have a nice rally. We'd be disappointed if we don't get one. Following the crash of '29, for example, the Dow rallied back to within 60 points of its all time high. The rally took 6 months and gave investors plenty of time to get out.

Instead, many concluded that the good times were rolling again. Alas, it wasn't so. The good times were over... and wouldn't really come back until the 1950s - 20 years later.

What we had in the '30s... in Japan in the '90s... and now worldwide... was a massive destruction of wealth. Well, wealth... such as it was. In all three cases, a huge, credit-led boom led to a huge build-up in speculative debt. Then, when asset prices fell... balance sheets looked terrible. People had to pay down debt and build up savings. That takes many years. And while it is going on, spending, investing and living it up are depressed. Obviously; people need the money for other things. Just look at Starbucks - the stock is down 75%. And Coach (maker of expensive leather handbags) - down two thirds. Tiffany has been cut in half.

Yes... the hard rain is falling on everyone, rich and poor alike.

*** Central banks lower interest rates to try to gin up some activity. They set up another round of drinks, hoping the party will get going again. The Fed cut rates decisively (if a bit slowly) in the '30s. Japan's central bank went further - taking rates down to near-zero and leaving them at that level for years. The U.S. Fed, meanwhile, has already hacked its key rate down to 1%. It's ready to cut more... if need be.

But the central bankers are missing the point. They're like a liquor salesman at an AA meeting. Everyone is desperately trying to sober up - not go on another bender. Of course, the feds will get a few people to take up the bottle again... but these poor saps will be even worse off.

In this type of correction, people need to correct the mistakes of the late bubble. That means getting balance sheets back in balance. And that means spending less and saving more.

Economists describe this problem as "pushing on a string"... or a "liquidity trap." The central bank can make more credit more readily available, but it can't force people to borrow.

Yesterday's news headlines included one that went to the heart of the matter; "Government to force banks to lend." But the problem is not so much the banks - it's the economy itself. Banks would be happy to lend - if they could be reasonably assured of getting their money back. But in a crumbling economy... who knows?

This is the tough financial situation that President Obama will face.

While monetary policy won't do much good, fiscal policy might. At least, there's plenty of temptation in fiscal policy... so much that powerful, ambitious and/or corrupt politicians - forgive us for repeating ourselves - always find it irresistible.

The principle is simple. If businesses won't spend... and consumers won't spend... the government will do the spending. This is the idea made popular by Keynes and known today as "Keynesian" economics.

"We are all Keynesians now," said Richard Nixon back in the '70s. As we said, the idea was irresistible.

Keynesian spending doesn't really make people better off, but it has three things going for it:

1) It gives politicians an excuse to spend more money

2) It looks like things are getting better... and at least government is "doing something"

3) It tends to keep the lights on

In the coming U.S. downturn, (we say "coming" because the worst of it is still in the future) consumers are likely to pull hard on their belts and send the rate of saving soaring. Maybe not the 20%-30% you see in Japan and China, but at least back to the 10% we saw before the 1990s. That will remove more than $1 trillion from the economy. Directly. Indirectly, it will remove a lot more.

And here we bring bad tidings of Christmas.

"Balloon bursts on festive parties in tough times," is a headline at the Financial Times. Companies are cutting back sharply on their holiday celebrations. We know that from personal experience. A memo just received from corporate headquarters in Baltimore tells us that the annual Christmas party will be greatly scaled down. "Employees only," is the word.

Well, the grinches in our own little company are generous compared to those in other firms. The big Wall Street firms "have scrapped extravagant parties," comes the word from the street. "What's there to celebrate?" asked one executive. "It's the year from Hell."

Certainly a "glass is half empty" way of looking at it. It's a correction. And in corrections, spending goes down as people correct the errors of the past.

In Detroit, GM and Chrysler have cancelled their big holiday bashes, too. Oh, the poor caterers! It's not as if there were a lot of upper-end work in Detroit these days. The caterers probably waited all year to put on a big do at Christmas for the carmakers. Then, wham, they cut off the juice... the party lights go out... and it's a cold, cold winter in Detroit. As if it weren't cold enough already!

The automakers are trying to cut costs as rapidly as they can. But revenues fall faster. Vehicle sales fell again in October - for the 12th straight month. This is the longest losing stretch in 17 years.

A writer for Britain's Spectator Business took a drive to Detroit to check on the state of things. Spotting a live human being in a huge parking lot... apparently guarding an abandoned factory... he stopped to chat.

"Ten years ago, this place was booming," said the guard. "Hard to believe isn't it? Back in '85 I used to work for General Motors fitting radios and cruise-control switches to the dashboards of cars. But they moved the factory somewhere else and that was that. Now I do security. Although what they're guarding this for, I do not know. There's nothing here."

Behind him was the apocalyptic scene we associate with Detroit. Then, referring to the American Dream, the guard took up his reflection:

"I thought it was the auto industry... with jobs and pension and health insurance and what not, but that went pop. Now they say they are building condos everywhere down here, but I don't know who they think is going to buy them. I guess that's another type of dream."

"It's time to wake up, America," continues the reporter, "this dream has become a nightmare."

So, in addition to the $1 trillion taken out by the savers... there's also the effect of less spending magnified all through the economy. The caterer doesn't get to serve up a holiday party... the baker doesn't get to bake... the liquor bottles begin to collect dust... from the guys who park cars to the babysitters to the hairdresser... the whole economy spins fewer dollars... people earn less... and they pay less tax. Then, at the far back of the income bus, the most marginal workers fall off altogether. The jobs they could get anytime before can't be gotten at all now. McDonald's begins to get choosey. It wants someone with a master's degree in fluid mechanics doing its deep-frying. And over at the Bright Nails shop, heck, they're looking for someone who used to be a chemist!

So the guys with few skills and spotty employment records can't get jobs at all. They should do like those fellows in Latin America and South Africa. They stand out on the roadsides, waiting for anyone to pick them up and put them to work... a day at a time... one hour after the other. They get paid at the end of the day - in cash. They should reduce the cost of their labor to the point where they're worth hiring, in other words. But this is the United States of America we're talking about. This is a democracy. And there are a lot of votes in the greater Detroit area... and a lot of Democrats who are going to be really cheesed off if their man in the White House doesn't do something to protect the voters from reality.

So what's Obama going to do? Simple, he's going to do what his most persuasive advisors tell him to do... he's going to borrow all those savings and put them to work. Everyone wants the safety of Treasury paper. Fortunately, the Obama Administration is going to give them plenty of it. They'll absorb the trillion or so in U.S. savings... and then everything else they can get their hands on - including much of the rest of the world's savings too. The U.S. deficit will soar - along with the national debt. Rates will rise.

And then... maybe 18 months from now... maybe 10 years from now... it will get really interesting...

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The town is underwater, reports the International Herald Tribune. Nine out of ten houses are worth less than their mortgages. There are some 1,856 mortgaged properties in the zip code area of Mountain House. Only 209 of them have any positive equity.

How the screw turns! Is this the "ownership society" promoted by the Bush Administration? Now, people own less than ever!

There are said to be almost 8 million houses with negative equity in the United States.

Of course, people own a lot less in stocks than they did a few months ago too. Worldwide, stocks have shucked off about $28 trillion worth of value.

Poor... rich... middle class - everyone has been hit. The marginal homeowner has already been tossed out onto the street. And now comes word that an extraordinary resort in Montana, designed for the super-rich, has gone bust.

"Where did the money go?" asked Montana governor Brian Schweitzer, speaking of Tim and Edna Blixseth's swanky resort in the Gallatin mountains. Of course, he might have been referring to almost anything - the Russian stock market, the oil market, the mining industry, Wall Street... everywhere you look... from trailer parks to Park Avenue... poof!... the money's disappeared.

The oil price is signaling more doom and gloom ahead too. It slipped below $60 yesterday...

... And now, in the art market, "prices finally plunge," reports the Daily Telegraph. An auction in New York of Impressionists and modern art was supposed to bring in $800 million. Instead, it barely fetched half that much - only $470 million by Friday night. Some lots didn't sell at all. Only 60% of the artworks sold... at prices most about 30% below estimates.

Let's take a quick look at how these losses are transformed from financial problems into economic problems.

"The domino effect," is how today's Independent describes it.

On the cover is the photo of a "news agent," someone who runs a little shop selling magazines, newspapers, snacks, and so forth.

"Hit by falling sales, he decided not to repair his window. Thousands of other people did likewise. So Chemix, a chemical company in Stockport that supplies the building trade, went out of business - with 60 people losing their jobs. These are the sort of tiny decisions that lay behind the loss of 5,000 jobs yesterday. And this is why experts predict 2,000,000 people [in England] will be unemployed by Christmas."

In the United States, the figure is 10 million.

So great is America's economic squeeze that people can't even afford a cup of coffee. Starbucks reports that its profits are off 97%. Not much left.

And, yesterday, General Motors shares fell to a new low of $2.79. The last time you could have bought the automaker so cheaply was in 1937. Back then, it would have been a good investment. The U.S. auto industry was on the way up. Now, Detroit is going down - hard. In the town itself, you can buy mansions for pennies. Empty warehouses are available almost for free. But who wants them?

Investors fear GM may run out of cash within weeks and be forced into bankruptcy. Nancy Pelosi says a special lame duck session of Congress may be called to get emergency cash to Detroit.

Of course, that's they way the feds do business - always trying to prop up failures... trying to block progress... trying to delay the process of correction. In short, they're trying to stop "nature's delight" - change.

Meanwhile, the Dow fell another 176 points. The panic is gone, but the retreat continues. The Dow stood at 8,694 at the close of business yesterday.

At these prices, many investment pros are ready to get back in. Stocks are a bargain, they say. You get more value for money than you got in years, they point out. "Both my money and my mouth say the same thing," adds Warren Buffett: "Buy equities."

Take a look at Starbucks, for example. It used to be such a growth company that shares traded at 50 times earnings. Now you can get them for 12 times earnings. But with collapsing earnings... the share price could fall a lot more.

The stock market bulls aren't necessarily wrong. But we announced a "Trade of the Decade" in 2000 - sell stocks, buy gold. The decade has a few more months to run, so we'll stick with it. At the beginning of this decade you could get about 40 ounces of gold for a unit of the Dow stocks. Now, you barely get 12. If you'd done the trade and stuck with it, you'd be up about 200%.

Besides, it looks to us as though the Dow is going to drop below 5,000 before this is over. Dividend yields have risen to almost 4%. When the dividend yield reaches 6%... and you can trade one ounce of gold for the entire Dow... call us.

In the meantime, we still think it's a good idea to take advantage of the low price of gold.

*** A few months ago, we wondered what the surprise would be. Mr. Market always has some tricks up his sleeve. What must happen always happens, but never as you expect.

So when stocks started to slide and people began talking about a 'soft landing for global growth,' we wondered where the surprise would be.

Now we know. The downturn has been much more violent than almost anyone imagined. And it's beginning to look as though the long-term damage could be much greater too.

Remember, a correction is equal and opposite to the deception that preceded it. Where was the deception of the boom years most concentrated? In two places - the United States and China.

Americans believed they could live beyond their means forever. China believed it could get rich by selling more and more manufactured items - even though its major customer couldn't pay.

You'd expect the resulting suffering to be equal and opposite to the aforegone enjoyment too. That is, those who lived highest on the hog should fall the farthest, no? And those who benefited most from selling to these people should lose most money.

So far, we've seen the beginnings of these redressments. But probably only just the beginning. Some people in America have lost their houses... some have lost their jobs. Spending has begun to fall. But the typical American continues to enjoy a standard of living that most of the world's people cannot afford - including most Americans.

It will get worse. The third quarter showed the biggest decline in consumer spending in 28 years.

This is a "balance sheet recession," remember? Consumers, businesses, investors - all need to pay down debt and build up savings. This will mean a huge turnaround for everyone - especially consumers. They have to reduce their standards of living dramatically in order to save money. And especially the baby boomer consumers - who also have to sock away some cash for retirement.

Saving went out of style in the '90s... but it's becoming very popular, very fast. We're going to see national savings rates rise... back to nearly 10%... and maybe beyond. This is exactly what consumers need to do. Consumers need savings. But the trend is murder on a consumer economy. A 10% savings rate means about $1.3 trillion in money that is NOT spent every year. (That's why Obama is going to have a $2 trillion budget deficit... more on that tomorrow.)

And here comes the bad news from the Wall Street Journal: "Retail Losses Sap a Jobs Safety Net."

We're not sure how you sap a safety net. But for millions of people, when budgets got tight, someone could always go to work as a clerk in a retail shop. The money was poor, but at least it was money. And it filled in the gaps. For retired people... students... part-time working spouses - retail employment was always there... a fallback position... a "safety net."

But with sales collapsing, the safety net is on the hard ground. The complaint of working stiffs used to be that "good jobs" were hard to find. You could always find a 'bad job' - flipping burgers or stocking shelves. But jobs with health benefits and union wages were few and far between. Now, even bad jobs are getting hard to find.

*** The other big loser will be China. Here, too, investors have suffered huge losses already. But China is still growing... still producing beaucoup stuff for people who no longer have the means or the desire to buy it.

"No one should underestimate Asia's exposure to this crisis," writes Richard Duncan in Far Eastern Economic Review. "At best, Asia is facing a severe recession. September 2008 may mark the end of the era of export-led growth, rather than merely the beginning of a more typical global recession. Asia's export-led economic model is just as threatened as the Anglo-Saxon model of highly leveraged capitalism."

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"Now, the hard part... !"

"Obama faces huge challenges... "

"Not an easy time for president-elect... "

And for once... the press is right. It won't be an easy time for Obama's team. But the president elect is moving fast; he's already got a meeting scheduled with an impressive list of advisors - including Warren Buffett and Paul Volcker.

And he's already got a plan, or at least the beginning of a plan, to deal with the economic threat. He's leaning towards what the press are calling the 'big bang,' approach - a combination of reform, quackery, giveaways, larceny, distortions, meddling, corruption and national bankruptcy. It will probably include a new health care plan, an energy program, a moratorium on mortgage foreclosures, higher taxes, income redistribution, loans and more bailouts.

"Obama can be a Roosevelt and not a Carter," writes David Blake in the Financial Times. "The cure for inflation is tighter money, tighter budgets and more unemployment," he continues. That is the situation that Jimmy Carter faced. And he faced it well; he hired Paul Volcker to run the Fed.

"The cure for deflation is a mix of interest rate cuts, more spending and lower taxes," according to Blake. What luck for Obama. He can do all the things that people love. He can be a hero... he can be another Roosevelt.

And here is where the press errs. The reporters think a balance sheet depression can be "cured." Just give the patient some of that old time medicine - the sweet syrup of more spending, more money, more credit and lower taxes. And almost all the reports we've read suggest that a combination of bold initiatives from Washington, along with Mr. Market's natural tendency to bounce back, almost certainly mean that things are bound to start looking up soon.

Not likely... instead, the 'big bang' is going to blow up in our faces... as we explain in a moment...

But let's stop and look at what happened last week: the Dow went down more than 900 points on the two days after the ballots were counted. Then, on the third day, the stock market rose from the dead. Or, at least, that's what the bulls were hoping. The bears were just hoping for another chance to sell out.

In any event, the Dow went up only 248 points on Friday. There were few signs of a turnaround. Oil held above $60. Gold rose $4.70 to $736.

(We asked our old friend - Issy Bacher, who predicted gold's drop - what he saw next. "The correction is not over," says he. Gold could still lose another $100.)

Obama is lucky he wasn't elected a year ago. At least now it is clear that he's innocent. He comes to the office facing problems not of his own making. Instead, they were made by his predecessors - notably, Alan Greenspan and George W. Bush. Working together, the two bumblers squandered America's fortune, drove off her industry, and put just about everyone deeper in debt than ever in history. Did two more hapless, more incompetent, more conniving half-wits ever before conspire to create such a mess?

Alan Greenspan courted power and fame. He got both. But you can't get power and fame without being a jackass. At least, that's our conclusion after reviewing the history of the United States of America. Just look at the presidents who got power and fame: Abraham Lincoln... Woodrow Wilson... Franklin Delano Roosevelt. The first two got the United States into unnecessary and disastrous wars... the last one got the United States into an unnecessary and disastrous depression.

Okay... okay... it wasn't entirely their fault... but it's our Daily Reckoning, we can exaggerate if we want to...

Alan Greenspan would have been much less popular had he put the brakes on the dot.com bubble in '97... and the brakes on the housing bubble in 2005. Of course, he probably would have lost his job sooner. But the United States would have a much healthier economy as a result.

And talk about unnecessary wars! And unnecessary depressions! George W. Bush has brought us both! No president ever presided over such a spectacular turnaround in America's fortunes:

... from a fake budget surplus of nearly $300 billion under the Clinton administration, Bush will leave office with a real deficit approaching $1 trillion...

... coming into Washington at the peak of the bubble of 2000... he'll blow out of town leaving behind an economy in its worst slump since the '30s...

... after taking control of the spiffiest, most widely respected country in human history, in 2000, he leaves a country that is widely regarded as broken down... (Russian president Medvedev recently charged the United States with causing the world's financial meltdown... the French believe US-style capitalism is collapsing, like the Soviet Union in '89... the Latinos now mock the idea of taking financial advice from the United States.)

... after coming into office lauding the virtues of humble foreign policy and proud capitalism, the United States has taken up a breathtaking combination of bombastic military intervention abroad and abject, swinish collectivism at home.

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Nassim Taleb has made a career out of warning people. His "Taleb distribution" describes the occasional apocalypse: usually, things happen in a respectable, bell curve kind of way... the way Fair Reason thinks they should... and then, all Hell breaks loose.

The last time the sky fell was 96 years ago. Few saw it coming; no one panicked. But panic wouldn't exist if it weren't a useful instinct from time to time. The celestial bricks came unglued in August 1914. By 1918, 40 million people had died. But that was just the beginning. WWI bankrupted or destroyed almost every major government of Europe. The plumy families that had dominated the continent for centuries - the Hohenzollerns, the Romanoffs, the Hapsburgs - were all clobbered. The Ottoman Turks fared no better. Then, scarcely 20 years later, France's Third Republic was another victim... and so was Germany's Third Reich.

But that was only the half of it. Between the two wars, came hyperinflation and destitution in Germany, America's Great Depression and something far more deadly - the world's worst plague, the Great Flu Epidemic of 1918-1920. The illness is known to us by its WWI alias, the "Spanish Flu." Propagandists didn't want the world to know how many French, American and English soldiers were dying of the disease. So they referred to it as though it only wiped out Iberians.

First spotted in young soldiers at Fort Riley, Kansas, the virus was soon found almost all over the world. Japan was the only major population center spared. Curiously, the disease killed off young adults more often than old people or children - somehow turning a strong immune system against its owner in what scientists call a "cytokine storm." How many people gave up the ghost? Estimates range from 20 million on the low side to 80 million top end - that is, at least twice as many people who had died in the war.

Before the 1914-1945 catastrophe was the 1789-1812 calamity - roughly the period from the French Revolution to the Battle of Waterloo. It not only included the collapse of five different forms of government in France - Monarchy, First Republic, Directory, Consulate, and First Empire - but also inflation, 3 currency collapses, major political debacles throughout Europe, the Napoleonic Wars, as well as the last major famine in France in 1795.

War, bankruptcy, chaos, plague and famine - when trouble comes, it comes with a mob at its back. As usual, the Greeks provided an early example. Athens must have been the Goldman Sachs of the classical world. But when these masters of the ancient universe tried a hostile takeover of Sparta, it failed miserably... leaving them as exposed Bear Stearns. Sparta counterattacked and laid siege. Then, the bugs joined the attack in 430 BC. Thousands were killed by plague - including Pericles himself. Weakened by disease, hunger and war, Athens surrendered, was enslaved, and the Golden Age was over.

Later, it was the Romans' turn. Bankruptcy, wars, stupidity - all took their toll. Then, in the 6th century, came another major onslaught: disease. Of the 80 monasteries around Constantinople in 540AD, none survived. Ghost ships, in which everyone on board had died of plague, drifted in the Mediterranean. European civilization seemed to fall apart.

Again, in the 14th century, came 100 years of war in France... along with starvation and plague. A couple of cold, wet summers caused famine in Western Europe. Young children were abandoned. Old people starved themselves to free up food for their families. Meanwhile, the Mongols attacked in the East, hoping to conquer all of Europe. And when they retreated, they left a going-away present - the plague. The Black Death of 1347-1351 killed off more people than the war or the Great Famine of 1315. Towns and fields were abandoned as a third of the population died. "So many died that all believed it was the end of the world," said Agnolo di Tura of Siena, who buried his five children with his own hands.

New Scientist magazine comments: "Many people dismiss any talk of collapse as akin to the street corner prophet warning that the end is nigh." But, more and more scientists are taking the end of civilization threat seriously, the magazine continues. Complexity - such as derivative financial instruments and "just in time" inventory systems - is making "our society... ever more vulnerable."

In his 1988 book, The Collapse of Complex Societies, Joseph Tainter argued that all societies - like all organisms - are doomed. Each challenge requires a solution. Each solution takes resources. Eventually, the solutions - and readers may substitute the word "bailout" for solution - brings more challenges and takes more resources. Eventually, the system collapses under the weight of if all.

When the stars fall, even the angels get out of town.

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