..that our children are going to spit on our graves!

First, Americans made a colossal mistake in the '90s and the '00s. They partied...they spent...they borrowed...running up huge debts in the private sector. Most kids could forget about inheriting anything from their parents; the geezers spent it years ago.

The boomer generation also made a mess of the biggest success story in world history - the United States of America. In the '60s and '70s - when boomers matured and began to take over - the US was still on top of the world. It had a positive trade balance...huge savings...massive investments abroad...and the strongest companies in the world.

They ruined it. The financial industry took over...replacing manufacturing. Instead of making things we could sell at a profit, Wall Street sold debt - mostly to us! In government, imperial ambitions pushed aside the restraints and good sense of the old republic. Overseas, military bases were set up in 120 countries. We now have unwinnable, trillion-dollar wars that could go on forever. At home, the sheep look to the government to solve every problem. Thirty-five million Americans - almost as many as the entire population of Spain - depend on the feds' food stamp program for their daily bread.

At least, most Americans are making amends in their private lives. The old days, when the US was "the world's mouth," are over. We can no longer be counted on to buy up every gadget and gizmo produced in the world. We're rediscovering the old virtues of thrift and savings. Frugality is back in style. If this continues, the Baby Boom generation may not leave the next generation with much net wealth, but at least it will not leave behind huge net debts.

But over in the public sector, the debt toll mounts up. The boomers want the government - which means, the next generation - to pay for their health care...their unemployment insurance...their bailouts and their handouts. The deficit for this year is expected to be about $1.5 trillion. Next year, it will be about the same. The feds say it is too early to pull back on their stimulus efforts. Housing credits and unemployment benefits have just been extended. A trillion-dollar overhaul of the healthcare system is in the works. Even assuming a real recovery - don't hold your breath - the deficits are supposed to run $1 trillion per year for the next 10 years. More likely, as we reported in this space a few weeks ago, the deficits will be $2 trillion per year. By the time today's 30-year-old gets a family...a house...and a mortgage, he will also have his share of a $20 trillion dollar deficit - not to mention the "off budget" obligations of the US government, a total of more than $100 trillion!

But wait...aren't these spending efforts paying off? Isn't the stimulus helping the US economy get back to into the pink? Don't all these federal spending programs create a safer, more prosperous world?

Ah...tell that to the kids! "We were just trying to get the economy back on its feet...so you could find a job in a thriving economy," we might say.

Take any two young people, 16-24 years old. Odds are, one of them will be unemployed. Joblessness among the young has hit 53% - a post WWII high.

Seven million jobs have been lost in the last 24 months. Employers are still cutting payrolls. And when business picks up...what kind of jobs are they going to offer? Will the next generation compete with the Chinese for low-cost production? Are they going to compete with the Europeans for high-cost/high quality production? Are they going to develop more mortgaged-backed securities? Or are they going to put on waiters' aprons and take orders from clients who no longer dine out?

Good jobs will be hard to come by. Because the 'growth' of the bubble period - 2001-2007 - was a fraud. Instead of building up capital assets and creating more jobs, people borrowed money ...and then squandered it. And now, the recovery is a fraud too. Now, the government pumps up the economy with cheap credit...borrows trillions...and wastes the money on pointless 'stimulus' programs.

And day after day, the debt builds up. Soon, it will be too big to handle. And then, these same young people - who can't get a foot onto the lowest rung of the employment ladder - will be asked to shoulder this huge burden of debt left to them by their parents. You can imagine their reaction...

..they will spit on our graves!

Bill Bonner
for The Daily Reckoning Australia

• Roubini Says United States Will Climb Out of Recession Towards End of Year
• Train Travel is Going to Make a Comeback in the United States
• The United States Matters Less and Less to the Oil Market
• World Economy Has Never Been in a Fix Like This
• Is Inflation Necessary for Recovery and Growth in the United States?

Interesting huh? Consumer credit has fallen off a cliff.

What does that mean exactly? It means Americans aren't borrowing...and they aren't buying either.

This weekend, The New York Times noticed:

"Americans stop buying; trade deficit declines" begins the headline.

This is the story we've been telling here at The Daily Reckoning for two years. Americans have to cut back. They are out of time and out of money. Ten years closer to retirement than they were in before the tech stock crash, Baby Boomers are not a penny richer. Now, they're facing a funky economy where housing prices are in decline, jobs are hard to find and lenders are reticent to lend them more money. Daddy has finally taken the T-bird away.

But wait...if the Baby Boomers stop spending won't it have, like, repercussions?

The NYT continues:

"For the first eight months of the year, the United States trade deficit with China is down by about 14 percent or $20 billion, compared with one year ago. The nation's trade deficit with Japan has shrunk by almost 20 percent, and its deficits with Mexico, Canada and the European Union are down more than 40 percent.

"The huge shift stems mainly from the staggering collapse in trade. With credit markets frozen and Americans facing the highest unemployment in more than 30 years, the United States suddenly stopped shopping overseas at anywhere near the volumes that had become normal."

Americans were the world's champion consumers. Just lend them money; they'd spend it. But when they stop spending it brings a hush to the entire planet. The malls go quiet...trucks slow down...ships are idled...and finally factories are shut down. Clerks, drivers, stevedores and assembly line workers all go home. That is what a depression is all about.

The feds are trying to get consumers to spend again. They've given them tax rebates, incentives, loans, and bribes. They've run a federal deficit three times higher than the previous record. They promise $1 trillion deficits "as far as the eye can see." And they put at risk a sum of money equal almost to the entire US GDP.

Still those hardheaded consumers won't consume like they're supposed to.

Suddenly, it's the 'Age of Thrift.'

But if it's really the age of thrift, the stock market doesn't seem to have gotten the message. The Dow rose 78 points on Friday, to a new post-crash high. Oil held at over $72. And gold lost $7 to close at $1,049.

What are stock market investors thinking? Are they thinking at all?

If the consumer credit party is over...and the Baby Boomers are on the wagon...is it really possible for US businesses to grow...and prosper?

Yes, it is. America has great businesses with great brands. As the dollar falls it should be able for them to gain global market share in some sectors. But 70% of the economy is consumer spending. Until that changes, the US economy is hostage to US consumer spending. When consumers stop consuming, the US economy's wheels stop turning.

Okay, so you're thinking: "Well...maybe Americans have to cut back, but there are plenty of other people in the world. Let them do the buying for a while!"

And you are right. America has less than 5% of the world's population. But it consumes more than 20% of the total world's output - as measured by GDP. Clearly, Americans have been doing more than their fair share. It's time to let the foreigners belly up to the bar. Heck, they're skinny. They could use a good drink.

In time, foreigners will spend more. We don't doubt it. But rebalancing the world's economies won't happen overnight. Nor even in a couple years. It will take a long, long time. And a lot of investment in new tools, new training, and new techniques. Until that happens, when US consumers stop buying it slows wheels all over the world.

Every time finance ministers and heads of state get together they talk about "rebalancing" the world economy. They promise to take steps to make it happen. But so far, the market is doing all the rebalancing work on its own.

And instead of letting nature take her course...allowing the invisible hand of capitalism to direct capital to where it is actually needed...the heavy hand of government blocks the process of correction.

Credit is still contracting. And Reuters reports that "small US firms face credit squeeze."

In theory, a genuine recovery in the United States could be led by exports. A cheaper dollar...and a cheaper workforce (in global terms)...would make the United States a better competitor.

But even a cheaper dollar is not guaranteed. Consumers may have stopped borrowing, but the US government borrows more than ever. This borrowing - in dollars - increases demand for greenbacks and may actually sustain the dollar at a higher level than it should be. The feds' appetite for borrowing could also force up interest rates - further restricting small businesses' access to easy credit.

There is a big difference between selling a few more Harley Davidsons overseas and real export-led economic growth for the US economy. The latter would require hundreds...thousands...of Harley Davidson enterprises, selling billions worth of goods and services to foreigners. And right now, those enterprises don't exist. They have no lobbyists trying to get TARP funds. They have no pet Congressmen slipping tax breaks for them into defense bills. They have no unions backing them. How could they; they haven't even gotten off the ground yet. And they may never get off the ground if they can't get financing.

The boomers are saving. They put their money into the safest possible place - US bonds! That is, they lend it to the government. They're the feds' biggest single source of financing - even bigger than the Chinese.

Meanwhile, the feds pump billions into the banking system. They supply the banks with capital for expansion and consumption. But instead of making loans to the private sector, the banks take the feds' money and lend it right back to them. They can borrow at a negligible rate...and then use the money to buy long-dated T-bonds yielding over 4%. Result: banks make money; the private sector has no money to create new businesses.

This weekend, we had a conversation with an English carpenter.

"It's rough. I remember just a couple of years ago, I could get work anywhere. Now it's off and on. I still find work, but I have a lot of free time too.

"It's not easy. Not with four children. We don't have any choice. We don't get any public benefits, you know...because I'm working. But I'm not working as much as I used to. And I'm not getting paid as much. So what can we do? We have to tighten our belts. We get by. But we're definitely not spending money they way we used to. In fact, I wish we hadn't spent so much back then. I'd like to have some of that money now."

A report in the Telegraph predicts British property prices - which have been in an upward trend for several months - are headed down again...with a 17% decline expected.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Until This Debt is Reduced, Americans Will Be Reluctant to Borrow or Spend
• Is Gold at $1000 a Bargain…Or a Trap?
• Baby Boomers Face Early Retirement With No Money Saved
• Boomers Made a Mess of the United States of America
• Americans Have No Money to Spend Because They Already Spent It!

We spent Sunday with the publisher of International Living magazine.

"Prices have fallen so much in Florida that you really get more for your money there than practically anywhere else," she continued.

"I think Florida may be cheaper than Buenos Aires," added son Will, who's been living in Argentina for the last three years.

Housing is cheap in the United States. In Texas and Arkansas, housing is probably the best bargain on the planet. Food prices are going up; still food in the US is much cheaper than it is in Europe. And cars? We have a friend in Paris who goes back to the US to buy his Mercedes. Even with the cost of shipping the car back to France...and the cost of refitting the car to European standards...he still saves about $10,000.

"I was just in Paris," Will continued. "You pay $10 for a cup of coffee and a croissant. In Florida, I can get the 'Breakfast Special' for $5.95...and it has everything. Pancakes. Bacon... Everything."

"But what is amazing," continued our International Living colleague, "is that interest in moving overseas is going up. It's not about money. Apparently, a lot of Americans are just fed up...or afraid. They want to get out. They see taxes going up or they see the society going down the tubes. I don't know. But many say they just don't like the way things are going.

"One thing I hear is that they think American society has become meaner...ruder...less civil. You can't have a polite discussion of politics anymore. People get really upset and nasty. I mean, someone yelled out and called Obama a liar in the middle of a joint session of Congress. And a substantial part of the US population regards the guy - the guy who called him a liar - as a hero. They think Obama is a traitor...

"I think this is really a result of the financial downturn. People feel betrayed. Let down. They think something is very wrong. That the nation is in decline. So they look for someone to blame. And they tend to blame each other. Conservatives blame liberals. Liberals blame conservatives. They blame the bankers. They blame the capitalists. They blame the government.

"I guess that's what happens when you get a major correction or a big financial crisis."

We recalled what happened in Germany in the '20s and '30s:

"Germany was probably the most civilized country in the world - before WWI. Artists, philosophers, scientists, mathematicians, musicians... Germany had the best in the world. The war shook the public's faith in its leaders. But then, according to people who lived through the period, the financial crises of the '20s and '30s were worse. Hyperinflation...depression...strikes...a decade of financial chaos and disruptions led to a breakdown in social order. By the early thirties, groups of communists and fascists were battling in the streets. People seemed to leave the center and move to extreme positions. Soon, the Nazis had the upper hand and Hitler was voted into the government."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Lending Rates Will Go Up With Inflation
• No Way Today’s Economy is Going Back to What it Was Pre-2007
• Does This Mean You Should Sell Your Gold?
• A Financial World Not Yet Recovered From the Bubble Madness of 2002-2007
• Baby Bush: The Worst President in History?

In this age of miracles, people seem ready to believe that anything is possible. Recklessly crossing the street at the end of the Late Bubble Epoque, the world economy got hit by a cross-town bus. Now, the feds propose to reverse and run over the poor fellow again. It will be as if they had reversed the film; the economy will be as good as new, they say.

But we are suspicious. And we begin today's rumination by examining the bus driver's motives.

In its naked form, government is not evil; it is merely a self- interested parasite, like a bank lobbyist. Its main value comes from its ability to elbow out other parasites. Of course, the typical citizen is no saint either. Instead, he is merely a parasite in the larval stage. If he is lucky enough or cunning enough, he could grow into a parasite himself. The citizen, generally, doesn't mind being lied to and robbed - just so long it is by someone he elected. Or at least by someone whom tradition or local connivance put in place. He does not usually resent his homegrown government, even though it routinely costs him a substantial part of his output. On the contrary, he grows so fond of it he even dons his helmet from time to time to protect it. Naturally, the feds return the favor.

The basic business model of government is to keep order, protect campaign contributors and lure supporters with the promise of other peoples' money. The game plan of the typical citizen is even simpler: to be on the receiving end, not the paying end. Over time, more and more of them get into position. And the whole society becomes more costly, and more corrupt.

In the United States, entire industries now operate as wards of the state. They may have too little capital. Or, their operations may be too costly. Or, their products may be simply out-of-date and unattractive. Still, government keeps them going - even at the cost of at the expense of competitors. And the money doesn't only go to business. Cities stay solvent only by the grace of federal government grants. Whole sections of the population depend on government - including 34 million who draw their rations directly from the federal food stamp program. The spectacle is breathtaking and alarming at the same time - like a Pakistani bus on a mountain road, freighted with passengers clinging to the roof. The old rust bucket could tip over at any time, but what politician would tell a voter to get off?

That preface on the state out of the way, we turn to the state of the economy. The key to understanding the great credit bubble of 1945-2007 is to capture the codependent relationship between China and the United States of America. It seemed to serve both parties well. Each enabled each other's excess. China added mightily to the world's supply - far more than was actually needed. America, meanwhile, did heroic work on the demand side. While the growth in the United States was led by consumer spending, the growth in China was led by capital investment; factories expanded, towns were built, and output was revved up. But there was a flaw. Americans ran out of money. After the '70s, they could only increase their buying by going into debt. This they did with insouciance bordering on insanity. Total debt rose 370% of GDP and then blew up in 2007, with major lenders forced into bankruptcy and mergers, while GDP sank at its fastest pace since the end of WWII.

Now, the old formula no longer works - neither for Americans nor for the Chinese. Despite the urging of their government, Americans cannot be expected to take on more debt in order to consume more stuff from China. As savings rates grow toward 10%, demand from the United States will collapse by an estimated $1 trillion per year. With the China trade now accounting for 83% of America's non-oil trade deficit, you'd think the Chinese would panic. They already have as much as two times the output capacity needed to meet real demand. They should trim their manufacturing sector, not expand it.

We draw out that relationship only to show how hopeless it would be to draw it out further. Borrowing to consume is merely tricking stuff from the future to enjoy in the present. By 2007, some $30 trillion worth of spending that would have occurred 'in the future' had already occurred in the past. Factories that would have produced consumer items for 2009 discovered that they had already produced more than enough of them in 2005 and 2006.

It would be better to invite the future in...let her collect her debts...and then get on with things. Yet government officials on both sides of the Pacific continue their numbskull efforts to revive the bubble economy. On the US side, the feds are trying to stimulate demand for more stuff. On the far side, Chinese stimulation is going into producing more stuff. As if the world didn't have too much stuff already.

But the role of government is neither prosperity nor plausibility...but protection of the pests and parasites. They will keep paying them off and carrying them along...until the bus runs off the road.

But it's not prosperity that government really cares about. The big bus keeps trundling along - picking up pests and parasites along the way. It will keep going until it runs off the road.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• China Was the Maker and the United States Was the Taker
• Roubini Says United States Will Climb Out of Recession Towards End of Year
• The United States Matters Less and Less to the Oil Market
• Is Inflation Necessary for Recovery and Growth in the United States?
• China Rises While United States Declines

Pity the poor Chinese. They've got $768 billion worth of them.

And pity poor Tim Geithner. He's over there right now on a fool's errand, lying to the Chinese:

"Geithner Tells Chinese its Holdings Are Safe," says the Washington Post.

Reuters went on to report:

"His answer drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home."

More on Geithner's visit to China later in the week...

"Those people did not become French in the last five months," says Mitch Daniels, Republican governor of Indiana.

He was referring to the people who re-elected him. His point was that Americans are not necessarily in favor of socialism. They may be fed up with what they see as the failures of capitalism. But they're not ready to vote for Nicholas Sarkozy.

But the country has clearly moved towards more government intervention in the economy. In 1986, 40% of Americans thought government regulated the economy too much. Now, 40% think it doesn't regulate enough. And get this... The Economist reports the results of a worldwide poll. When asked if "people [were] better off under free markets," 75% of Indians say 'yes' and so did about 72% of Chinese. But put the question to Americans and only about 69% think so.

Even Italians are more in favor of free enterprise than Americans. Go figure.

The Economist passes along the thoughts of an American lawyer to explain it:

"The disaster in the housing and mortgage markets shows that free markets don't always get incentives right or generate the information people need to make wise decisions. There may be times, he adds, when government is better suited to giving people the information they need."

Ha. Ha.

Information? What information was it that people didn't have? All the information was not only available - it was free. We reported it here at The Daily Reckoning - for free. Day after day...we read the headlines and passed along the statistics. What was hidden from view? What was unknown?

This information was available to the government too. Its thousands of regulators, representatives, researchers, and consumer advocates had computer terminals and newspaper subscriptions. They even had thousands of PhDs in economics whose JOB IS TO STUDY THE ECONOMY!

If government were really able to give "people the information they [needed]," you'd think that one of these earnest meddlers would have whispered to Secretary of the Treasury...or maybe to the head of the Fed: "Hey...better tell the voters to watch out...this thing is getting out of control."

But do you remember a word from the Secretary of the Treasury...from the Fed...from the SEC...from the other busybody parasites who live on the public payroll? We don't. All we remember is how they told us to "buy an SUV" and how derivatives "spread the risk to those who are able to bear it" and how "subprime mortgages help increase home ownership."

The government, do a better job of running the economy? Ha. Ha.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• American Family’s Share of Government Debt Now Over Half a Million Dollars
• Rule Thumb for Modern Times
• Chinese Economy Seems to be Growing
• Chinese Laughter the Sound of US Stupidity
• Fannie and Freddie in a Free Market Economy

...Still, the world did not stand still so Americans could enjoy their fireworks and hotdogs.

"Americans are so nice...so positive. I always like going back to the United States." This was the word from Elizabeth, who just returned from the Land of the Free this morning.

"When you live in France you forget how nice strangers can be. But it is amazing how big people have gotten."

(Being "nice" is something Americans strive to be; it is not something the French care about particularly. Instead, on the surface, the French are "correct" or polite. Later, you find that they are as nice as Americans, but not as big.)

Meanwhile, bad things continue to happen to nice people:

"Credit crisis is going to get worse," says The Wall Street Journal.

Elsewhere in the paper it was reported that the rate of joblessness for more than six months is rising.

And this from Kiplinger's: "Home equity door slams shut."

House prices are down across the United States. In Southern California, for example, the typical house is about 20% cheaper than it was two years ago. In some areas, where developers built thousands of new houses, prices are off as much as 40%. To make matters worse, many of these houses are far from town centers - requiring long commutes for work, shopping or entertainment. And gasoline is a lot more expensive than it was when the houses were first designed.

Americans earn dollars. But the "almighty dollar no longer exists," says the Associated Press. They have a currency without purchasing power...or staying power.

Americans are all set - for a world that no longer exists. They have home equity lines and credit cards - but the easy credit is disappearing. They have their suburban palaces and their land barges - but they can no longer afford the energy required to run them. Even their eating habits evolved for a different world. Real wages failed to rise, so families put more people to work...and gave up home-cooked meals and backyard gardens in favour of dining out. Restaurants - in an era of cheap food and cheap energy - competed for customers by offering bigger and bigger portions. Everything got supersized - people too.

Now Americans are getting their supersized desserts. Not because they haven't been nice. But because they haven't been good. That's how free enterprise really works; it rewards virtue - hard work, saving, investing, learning, taking risks, etc. As for those who spend too much and save too little - it kicks them in the derriere.

Today, they need to borrow almost $3 billion per day simply to make ends meet. And half the national debt - about $5 trillion - is owed to foreigners. Much of that money is in the hands of central banks, as part of their $4.8 trillion in foreign reserves. Then, there is a mountain of dollars in the hands of Sovereign Wealth Funds. (Tomorrow, we will have more to say about SWFs...)

It's the biggest transfer of wealth the world has ever seen. And it comes in many different forms. Billions are transferred from American motorists to oil-exporting countries. There's also the billions transferred to the auto-exporters. When Americans buy cars today they're more likely to buy one made by a foreign company than one made by the Big Three. And there are the billions shipped over to food exporters too. America used to be the biggest exporter of food in the world. Even today, we've seen estimates that the entire world's population could be fed on what America COULD produce. But when the United States got squeezed by high energy prices, Americans decided to squeeze energy out of their own food crops. Result: they pay record prices for energy AND food.

Of course, it wasn't just money the U.S. was sending abroad. It was also know-how, technology, and habits. The habit of saving, for example, packed its bags in the early '90s - and moved to Asia. And foreign students filled America's best universities and then often went back to Korea, or China, or Vietnam - taking their equations with them. Back at home, they set up newer, better factories - and ate America's lunch! Back in the late '90s, this loss of manufacturing seemed not to matter. Americans came to believe they could do something better than making things - we could create, invent and finance. "They sweat; we think," was the conceit.

But how do you like those foreigners? It turned out, they could think too. Not only that, but the combination of thinking and making things proved hard to beat. Like Japan before them, the exporting nations soon equaled U.S. quality...and then surpassed it. The United States is now a net importer - of energy...of food...and even technology. At least, that's what we hear. And finance? It's collapsing...and will probably return to where it was before the credit bubble. Historically, the financial industry provided only about 10% of U.S. corporate profits. In the bubble, the percentage rose to 40%...and is now headed back down.

Wages are rising in China, India, Russia and Brazil...but they are stagnant or falling in the U.S. of A. We reported the staggering fact in these reckonings last week: Since '67, consumer prices are, officially, up seven times. Wages in America are up exactly the same amount. In other words, during your editor's entire adult lifetime Americans' per hour earnings have not increased a single penny.

Funny none of the presidential candidates mentioned it.

Bill Bonner
The Daily Reckoning Australia

• Beat Food Price By Planting Your Own Garden
• America’s Service Industry is responsible for Low Wages
• Are Farm Prices Destined to Rise as More People Compete for Food?
• Energy Prices Are Going Higher
• The French are Feeling Pretty Smug

Then, we heard a chant. This was not an airport alarm, this was a group of protestors...trying to disrupt the airport. Why? We never figured it out...

It was Independence Day in the U.S....and Americans have never been more dependent on the kindness of strangers. The foreigners have some $4.8 trillion on currency reserves - most of it dollars.

Most Americans are enjoying their picnics and fireworks today. But here at The Daily Reckoning headquarters in Europe, we recognize no national holidays and only take a break when we can't get an Internet signal. There's always something to reckon with.

Today, for example, marks the 232nd anniversary of the day when colonists in North America decided to bite the hand that fed them. Supported by the English crown...defended against the French and the Indians by English soldiers and English money, nevertheless these traitors, rebels, and terrorists wanted to decide for themselves how they would be misgoverned.

"No taxation without representation," was their beef.

Too bad they couldn't have lived long enough to see the mess their descendants made of the place. Taxation with representation turned out to be much worse. From an estimated tax rate of less than 5%...the current lifetime rate - when you add up the accumulated effect of federal, state, and local income, sales taxes, road taxes, death taxes, capital gains taxes...and other taxes - is well over 50%.

But times change. And people come to think what they need to think when they need to think it. Less than three generations after declaring independence, the yankees decided they would rather kill their brethren in the South than permit them the same liberty. And now, 5 generations later, the United States has become the world's leading empire...and reserves to itself the right to decide what form of government other nations will have - even those half-way around the world.

Alas, the Brits found that bossing others around was an expensive enterprise. The British Empire provided order all over the world - which was a boon to commerce. But under the protective wing of the empire, other economies - without the expense of such a huge military establishment - proliferated like lice. By the beginning of the 20th century, both the American and German economies were bigger than Britain and growing faster.

Now, America bears the expense of policing the world. And its rivals take advantage of Pax Americana to pile up dollars and steal market share.

T. Boone Pickens calls it the "greatest transfer of wealth in history." He's referring to the oil market, where Americans take money out of their pockets and use it to buy gasoline; the cash ends up in the hands of the oil exporters - notably Russia, Venezuela and the Arab states. But the transfer of wealth goes back further than today's high energy prices...

It began with the easy money policies of the Fed following the crash of '87...and the free-spending habits of the American people and their government. The more Americans borrowed and spent...the more money ended up in the hands of foreigners. Normally, the mountains of American cash building up overseas would have caused inflation at home and landslides in the currency markets. But Asian exporters could make things cheaper and faster than American manufacturers. This, combined with technological improvements and just-in-time inventory techniques, tended to hold prices down. Prices looked so stable, central bankers thought they were geniuses and continued to pump out cash and credit. Then too, the strangers were exceptionally kind; normally they would have dumped their dollars on the world market - provoking a currency crisis. Instead, the Asians lent the cash back to the United States - thereby giving Americans even more rope to hang themselves. They could use the credit to buy more stuff - from the Asians. They didn't need more stuff. They didn't need bigger houses. And they didn't need big SUVs to drive them to distant jobs and shopping malls. But that's what over-reaching is all about - buying things you don't really need with money you don't really have.

Gradually, the Chinese developed more industries and more infrastructure. Soon, they were competing not merely on price...but on quality too, just as the Japanese had before them. And then, as they accumulated more and more money, they began to compete with the developed countries not only far raw materials - but for food. First, the price of oil shot up. And then, Americans (and Brazilians) tried to replace fossil fuel with fuel made from corn and sugar cane. This pushed up the price of grains. Corn has risen 64% in 2008 alone. Soybeans are up 37%. Oil itself is 50% more expensive. (Yesterday's trading left it unchanged - at $144 a gallon.)

"This whole economic phase is about taking Americans down a notch," we told a friend over a glass of wine yesterday afternoon. It really is a classic case of imperial over-stretch...where Americans reached too far...spent too much...borrowed too much...and lived too high. Now, they're facing a major correction - with falling living standards, falling wealth, falling power, and falling prestige. There's no way out...the best they can do is to take their medicine as gracefully as possible. There are no magic levers Ben Bernanke can yank. No miracle knobs he can turn."

We should add that it's not only Americans who are being taken down. The British too are facing a correction of their own.

"British economy falling into an American-style slump," says the headline in the International Herald Tribune.

No wonder. The Brits borrowed even more than Americans and now have more debt than we do.

*** Finally, police in Kentucky arrested a woman and charged her with trading sex for petrol. The local prosecutor said it saddened him to see people selling their bodies for petrol. She was charged with conducting a business without a proper license.

Bill Bonner
The Daily Reckoning Australia

• George W. Bush Presents Middle Easterners With a Lengthy ‘To-Do List’
• Feds are Getting Plenty of Taxpayer Support
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• The Infrastructure in the United States
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The John Button Car Plan doesn't seem like it was terribly popular at the time. But dropping tariffs exposed Australian industry to global competition. That competition eliminated firms (and jobs) that existed because the barriers to entry for foreign producers were so high. It also gave consumers better products at cheaper prices. Individual industries unable to compete globally lost out. But consumers won.

Still, Australia is a tough spot when it comes to the division of labor. In a country of just 20 million people, you are not going to be able to produce a huge variety of manufactured goods. There are just not enough people for the division of labor to work-where you can build up specialists in all sorts of manufacturing disciplines.

Australia's situation is not nearly so dire as say, Mexico or even some of the Gulf countries. Those countries are reliant on one commodity for a large part of their economy. Australia has a diversity of natural resources. But when it comes to innovation and economic diversification, there's plenty to accomplish in Australia.

On a different note, we found a great article written by John Button the February 2007 edition of "The Monthly" magazine. The article was called "America's Australia," and referred to a 1942 book called "Instructions for American Servicemen in Australia."

The book tried to help American soldier in Australia (there were 1 million of them in 1942, compared to seven million Aussies) understand more about their local hosts. It had some dubious definitions of Australian words. But since we were on the subject of the differing attitudes between Americans and Australians this week (with respect to guns) we found the article really refreshing.

We know what America is. It's an abstract idea of equality. It's based-correctly or not-on the proposition that all men are created equal. Americans are big believer in reinvention and self-invention. If life is getting you down, you could simply pack up and start over somewhere else. Mobility-social, economic, and physical-is key to understanding why America's are so future focused and un-traditional.

We wouldn't think that Aussies are traditionalists either. Both countries are young. But they clearly don't have the same set of values (if millions of people can be said to hold the same values, or believe in the same national mythologies.)

As for us, we like both cricket and baseball, VB and Budweiser, Sydney's Northern Beaches and Colorado's Rockies. As for Australian values, we are still trying to figure those out. Button gives us his take, while comparing Australians to Americans.

"We spend time trying to describe our differences from Americans because they are the people we are most like, and our identity as Australians depends on difference. In the process, we end up defining some things which are these days described as 'Australian values'.

"The prime minister [John Howard at the time] has been good at this. In speeches on various important occasions, he has referred to our virtues as being 'a fair go and practical mateship' (part of our 'creed'), 'a sense of fair play and a strong egalitarian streak', 'decency and pragmatism in a classless society', 'tolerance and hospitality' and 'those laconic characteristics which we hold so dear'.

"Perhaps 'Australian values' are not as immutable as might be believed. The things we 'hold so dear' - the mateship, the sense of fair play, the egalitarianism, the laconic characteristics - came out of a convict heritage, and later from the shearing sheds, the mines, the construction sites, the trenches of World War I: from all those places where hardship was endured and collective action was the most meaningful response....

"It is possible that Australian society may come to resemble, by default, some of the worst aspects of American society. For me, this would be a tragedy, because I like John Howard's stated Australian values, and neither an individual nor a country can live on nostalgia. And if this happens, there's no way we can blame the Americans, which we sometimes like to do. As our forebears used to say, we might just end up looking like a mob of drongos."

Dan Denning
The Daily Reckoning Australia

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An investor needs a baseline. He needs to be able to figure out whether he is making progress or backsliding. An American typically keeps score in dollars. But there's the rub... the dollar is a baseline that keeps moving. When the euro came out in 1998, it quickly fell against the dollar - from $1.12 down to 88 cents. That was the era when the NASDAQ was flying and Americans were still the world's most admired people. Since then, the tech stocks have crashed... the information age has proved a disappointment... the War against Iraq didn't go as planned... housing has gone down... and Wall Street has shown itself to be as incompetent as the rest of us. (We all knew Washington was incompetent already.)

And now, as if to underline the point: Europe's esperanto money has risen to $1.55. In terms of what a dollar will buy in the United States, a dollar is down around 25% so far this century. In terms of what it will buy in Europe, it is down by about 50%. In terms of gold, it has shrunk 75%.

So where should an American keep his money? This was a much easier question when gold was under $500 and the dollar was worth more than the euro. Of the three, the dollar was the last place you wanted to be.

But now the buck is already down. Will it go down even more? Or is it time for a dollar rally? Now we're not only uncertain... we're unsure too. It is still early in the credit crunch. If it crunches hard enough, the dollar will pop up... squeezed out like a pea from a peapod. On the other hand, there will probably come a time when the feds bring out the helicopters and begin throwing dollars out of the cargo hatch. Then, like Germany in the '20s... Argentina in the '80s... or Zimbabwe today (see below)... we'll see some real inflation!

In the meantime, it's probably best to play it safe. Here's what we're doing with our own money: we're splitting our cash into three parts - and putting each third, equally, into gold (which we expect to double again from here)... Swiss francs, (because we fear the dollar could fall apart at any moment)... and the dollar itself (because you never know.)

*** Zimbabwe is back in the news. The inflation rate has risen from 100,000% to 200,000% since we last reported on the situation. But no one is counting very closely. Speaking of a cost of living increase in Zimbabwe is a like speaking of an increase in the snake population in Ireland. There isn't much of living to be had at any price. The shelves are mostly barren.

The big question in Harare is not whether Mr. Mugabe will win or lose the election on Saturday, but how he will steal it.

Bill Bonner
The Daily Reckoning Australia

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Friday saw another small drop in the Dow - minus 28 points for the index.

Bonds too, are maintaining a silence. Some days they are up. Some days they are down. If trouble were really on the way, you'd think the bonds would see it and raise an alarm. Instead, if they do see trouble on the horizon, they're keeping mum about it.

And what's going on with retail sales? If consumers really were feeling the squeeze we think they ought to be feeling, they'd start spending less money right away. But the evidence is mixed. Some numbers show a big drop in consumer spending... others show consumers still opening their wallets.

What to make of it? We don't know, but as usual, ignorance doesn't prevent us from having a theory... or even two.

One obvious takeaway is that the future isn't going to be as bad as analysts seem to think. If the economy were really sinking, the optimists say, these indicators would tell us.

A less obvious takeaway is that it will be much worse than expected. Mr. Market is an old trickster. What if he were setting us up to believe the economy would bounce back... when, really, it is headed down forever? As we parted company at the end of last week we suggested that the top might be in, not just for housing and stocks, but for the United States itself. Who wants to believe it? No one. But everything eventually peaks out... and every empire, no matter how great, is eventually scuttled.

It seems perfectly plausible that all-time highs may have come and gone for the US of A. Asians, Russians, Arabs - they are all offering more competition than Americans ever faced before. And in this new contest, Americans have not one, but both arms tied behind their backs. They no longer have enough energy to power their economy; they no longer produce enough food to feed themselves; they spend more than they make; they have higher debts than anyone, higher fixed costs, older equipment, and an older population. And they have an entitlement culture that cannot readily adapt to a more challenging environment. Instead of warning Americans that they need to cut costs, save money, and compete with the rest of the world... voters are being told that they can buy even more stuff, and that, by some magic as yet never explained, they will be protected not only from fierce global competition, but also from the consequences of their own errors.

But if our guess turns out to be correct, maybe never again will U.S. property prices - in real terms - be as high as they were in 2006. Never again, will U.S. stock prices be as high as they were in 2000. And never again will the United States enjoy such a lopsided advantage in wealth and power as it did at the end of the 20th century. Of course, it's much too early to tell. We won't know for 20... 50... or even 100 years.

But if this were true, why aren't the markets giving us a heads up?

We have a theory for that too.

What we are watching in the financial markets is a war. But it is a war like the war between Iraq and Iran in the 1980s. Henry Kissinger once remarked that "it is a shame both sides can't lose." In fact, both sides did lose. Millions of people were killed - at huge expense. Neither side gained a significant advantage. Of course, the same could be said for a lot of wars... maybe most wars. WWI left all the major combatants in worse shape than when the war began - with one exception, the United States of America. The rest were battered almost beyond recognition. Nations were bankrupted, currencies collapsed, empires fell, ruling families - Hapsburgs, Romanoffs, Hohenzollerns - were eliminated, the map of Europe changed... but scarcely anyone was better off.

The present war between inflation and deflation is going the same way. One side gets beaten up. Then, the other side gets walloped. Even when one gets an advantage, it comes at a high price.

Why is the stock market not falling more decisively? Can it not look ahead? Maybe it is looking ahead. And maybe it sees victories by both sides. In other words, maybe it doesn't see growth and prosperity at all. Maybe it sees a war without a winner... a slump... and consumer price inflation too.

M3 is the fullest measure of the money supply. And prices tend to be set by dividing the available goods and services by the mass of money in circulation. The more money, the higher the prices. Ideally, M3 and GDP (a measure of goods and services) go up at about the same rate and prices are stable. But currently, M3 is increasing about six or seven times faster than GDP. One explanation for the retail sales figures is that they are increasing largely because the prices of necessities are going up. In other words, consumers still have to spend more money - just to get the basics. Wheat prices are up 3 times in the last 12 months. Consumers still want bread... and now they have to pay a lot more for it.

So, maybe the stock market is looking at this situation, too. And maybe it sees stocks as a protection from inflation... maybe it's guessing that an investment in a profit-making business is a better place for money than a bank account. Maybe it wants to go up because of inflation... and wants to go down because of a coming slump. In the end, it goes nowhere.

And maybe the bond market sees the same picture. Maybe it sees a slowdown... which would be good for bond prices... but rising rates of inflation too, which would be bad. What should it do? It doesn't know any more than anyone else. So, it bides its time, waiting to see how the war will turn out.

Bill Bonner
The Daily Reckoning Australia

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