And when we ran out of money, no problem! There was more where that came from. In one sense we couldn't spend money fast enough. As soon as it was gone, there was more suddenly available. So we just finance the house again, take out some equity (which always rises) and do one of two things - Pay off credit cards (so we can load more debt on them) or just spend the cash on things a home improvement (that is no longer reflected in the price of the home) or a vacation.

Remember how MasterCard taught us that those memories were priceless? Hope you got some good ones... because you "done bought something you can't eat," as one of my teachers used to say.

At a time when we are drowning in debt, we are also out of money.

When a debtor is out of money, he has no ability to repay. And when a creditor has borrowers who are out of money, the creditor has no income. No earnings. No power to make better loans.

So how are banks in America posting "profits"? How did Citigroup, Bank of America, AIG and Wells Fargo jump 400% in stock price? Are they worth 400% more? Are their earnings up 400%? And where in the world did all this money come from?

These companies were just bankrupt... yet found a way to get back above water. And not just above water - they are making moon-shots!

Their share price should be zero (or less, if possible!). How are they worth so much more now?

As I have written before, mark-to-market accounting rules were repealed in favor of a fictitious slight of hand. Banks no longer have to list their distressed assets at the fire sale price they should be worth. Instead they get to record their value as the price they bought them, or what they believe they will be worth in the future.

In other words, it's like me refinancing my house, but doing my own appraisal and assigning it whatever value suits me. I want cash out? Just pad the value of the house. I can't afford a higher payment? No worries, I just pad my reported income. Two years down the road I can't afford my payments anymore? Easy, just follow the same refinancing procedure all over again.

But my family and I would only have one toxic asset to deal with. The banks have them coming out the wazoo!

They are still in possession of the faulty loans and derivatives that caused this entire mess in the first place. Nothing has changed - except the accounting!

The banks always counted on that. This time, however, they are the ones left holding the bag. What are they going to do with all this JUNK? How can they unload it without attracting suspicion? How can they clean up their books without the short sellers making a profit off their downfall? They can't. It's a Catch-22.

But the real problem is that the US banking system would come crashing down in a minute if this were known and understood by the general public. The banks know it. The Fed knows it. I suspect that there are some congress people who know it.

But here's where the rubber meets the road. Government engineered a bailout. They wanted the banks to lend to Joe Consumer. But the banks didn't. And frankly, Joe Consumer didn't want it. He was too busy trying to figure out how he was going to repay all the money he had already borrowed against his house. Especially with the boss breathing down his neck, threatening job terminations if he wasn't more productive than some cheap labor in India.

So the banks were sitting on a good deal of the money from the Fed in order to protect them from future losses. Some of them have even paid it back. But the truth is, from an accounting standpoint, they don't need it anymore. From an accounting standpoint, their mortgages and derivatives are all valued at a big fat surplus. Why keep federal money? Why incur interest charges when "all is well"?

If they can show a profit from an accounting standpoint... and if they can repay their bailout money (plus interest)... and if they can still service the customer at the drive-in window or the teller counter, what's the big deal? What am I crying about?

It's all because those toxicities still exist. And they all have to be accounted for, whether the government says so or not.

We should have learned, or have been reminded of, one of the greatest lessons in the world from convicted felon Bernie Madoff: "Be sure your sin will find you out."

Even the greatest engineered schemes on the planet come undone at some point. No Ponzi scheme can continue forever. But if you are very bright (as Madoff was), you can keep the game going for a long, long time.

But what if you're not brilliant? After all, I doubt the government is as smart as Billionaire Bernie. Luckily, if that's the right word, the government has another way to keep the game going, using one thing it has that Madoff didn't.

Cash.

Gobs and gobs of it.

The government's massive wad of cash is what keeps the game going. And foreign investors lending us money. And millions of pensioners happy as long as they receive their check on the first of the month. And the multitudes of purchased votes that are blissfully sitting on the dole.

But it's not just the United States. Every country in the world is in the same pickle - because every developed nation believed they could successfully manipulate the game. The problem now is that the governments are running out of money. The United States has been broke for a long time, of course, but it could still trade on the value of its good name... and it did. Other nations are not so lucky.

The United States still possesses the reserve currency status; other nations aren't so lucky. We still boast the largest GDP; other nations are not so lucky. I'm pretty sure we still have higher tax receipts, and more room to raise taxes than other nations. But somehow, I can't bring myself to call that lucky...

But as it is an "option," I have to think that whatever smarts our government does have, someone will eventually realize it. Good Lord, deliver us.

I do not honestly think that anyone can seriously contest us in the role of reserve currency, no matter how many times China rattles the saber.

Twenty years ago, China couldn't even feed its own people or keep them employed. Now it is boasting a 7% annual growth rate. Despite the massaging that may be done to the numbers before they are released, we can already see that a country growing solely on stimulus cannot grow very long. The weaknesses in China's underbelly are already becoming apparent. She is an export economy. And people are not buying.

She cannot save the world, whatever her strength might be.

There is another round of destruction coming. The banks will have to come clean. If you thought the residential crunch was stunning, wait till you see what's coming on the commercial front. It will be a tsunami of epic proportions. Banks are not lending now, and the chances of business expansion are lower than at any time in recent history. No one will be buying excess of anything except maybe food and precious metals, so businesses will not continue to post profits. Without profits you can't service the loans you have, and rolling them over will be out of the question. The day is coming... don't let it catch you by surprise.

But until that day arrives, we must deal with what we have.

Regards,

Bill Jenkins
for The Daily Reckoning Australia

• Gold Coins for $870-$890 An Ounce
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• The Baddest Bank in the West
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But first, what the stock market and the economy are doing...

In the past two days, the price of gold has shot up more than $40. It's now near $1,000 an ounce.

Why? We don't know. Rumors, talk, noise...there's plenty of that. But as for why investors are suddenly putting so much money into gold, we'll have to wait to find out.

But should you buy gold now? The answer is simple: yes and no.

The Trade of the Decade is still buy gold/sell stocks. And the decade isn't over. If you have US stocks, this is a good time to sell. The Dow went up 63 points yesterday - a weak bounce after several days of losses.

This is no time to hold stocks - for the reasons we outlined yesterday.

But gold? Should you buy gold and hope to get rich when gold shoots up to $3,000 an ounce? A bad idea, in our opinion. You should buy gold to protect your assets. The risk is in the paper money...because they can create as much of it as they please. And they're under pressure now to create a lot. You buy gold as insurance against inflation, a dollar bust, a bear market in stocks and bonds, or a financial crisis. Gold is nature's money. It is better than manmade money. Because, with gold, what you have it what you've got. They can't artificially depreciate it or easily increase the quantity of it. That's why the feds don't like it. It won't support their cause du jour - whether it is a war, a bailout, stimulus, health care, or whatever. Gold doesn't cooperate with the financial engineers. That's why it's a good thing to hold when you think the financial engineers are making a mistake.

But our view at The Daily Reckoning headquarters is that while the engineers are making a mistake, they not very good at it even when they're making a mistake they're good at. Typically, they're pretty good at causing inflation. But now the credit bubble is deflating, not inflating. It will take them a few years before they become reckless enough to move prices up again. And then, they'll probably overshoot their objectives considerably.

In the meantime, there's no inflation to speak of...no dollar crisis...no bond bust. So we wouldn't expect the price of gold to soar...not just yet. That's the big surprise - that this period of deflation will last longer than expected. Then, when it begins to seem permanent, inflation will suddenly come roaring back.

By then, most investors will have given up on gold...especially those who were speculating on it going to $3,000. It will go to $3,000, but only after speculators have dropped their positions.

So far, everything is happening just as we expected. After more than half a century of boom, we are now in a bust. People need to downsize...cut back...and live a little less large than they had in the boom years. That means...well...just what you'd expect.

Wasn't it just yesterday that we reported that Florida was losing population? People just aren't retiring like used to. Here's comes the evidence:

From The New York Times comes this headline: "Older US Workers Put Retirement on Hold."

The Times tells us that older people are continuing to work because they don't have a choice. They can't afford to retire. So they hold onto jobs, which is another reason it's so hard for the unemployed to find a job. Those who have them aren't giving them up. A Bloomberg report today, for example, tells us that more people are applying for job benefits than expected. Another tells us that millions of people are running out of benefits before they find a job.

Just what you'd expect, in other words. Here are some of the other things we expected:

1. Unemployment is still rising.

"Investors discouraged by US jobs report," says a headline at the International Herald Tribune. To make a long story short, August was a disappointment. More jobs were lost than expected.

We don't know how many jobs we should expect to lose. But we're in the downhill part of the credit cycle; we're bound to lose a lot of them.

2. Sales are falling.

That's another thing we would expect. People have to cut back. So...they do cut back. Sales go down. That means fewer sales and fewer jobs. No point in making things, shipping them and retailing them if no one is buying them, right?

3. What else would you expect? Lower house prices? Check. Higher savings rates? Check. More bankruptcies? Check. Falling prices? Check.

Isn't it nice when things work out "as they should?' Check.

Bill Bonner
for The Daily Reckoning Australia

• Should You Buy Stocks Now to Take Advantage of Bull Market?
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Why would you pay 40 times earnings for a homebuilder? It's a fairly easy business to enter. No barriers to entry that a little money...a few connections...and a circular saw can't overcome. With no barriers to entry, profit margins are always squeezed by competition. And growth is limited too - other builders are always starting up. If the investor paid 40 times earnings, he can only get 2.5% on his money - if the company pays out 100% in dividends! So, why pay so much?

The answer has two parts. First, China is providing stimulus to its economy on a mammoth scale. It gave the signal to its banks. The banks responded by opening the flood gates. Loans in the first half of the year measured three times those of the same period a year before. Naturally, this liquidity had an effect. The economy is booming. Everything credit can buy is being bought. But, as we at The Daily Reckoning know, you can't buy real prosperity on credit.

And the other reason for the bubble in builders' shares? Investors - especially investors in China - have learned nothing from the crash of '07-'08.

These are our little secrets, aren't they, Dear Reader? The rest of the world seems unaware of how the investment markets work...and they think credit is Miracle-Gro for the economy.

But markets are not mathematical...nor mechanical; they're moral. Their purpose is not to make people wealthy, but to make them wise. And then...only for a while.

It they were mathematical you might make people richer by adding zeros. But it's not that simple. Zimbabwe tried it; it doesn't work. A Dear Reader gave us a $10 TRILLION dollar bill - real money printed by the Zimbabwean Treasury. That - and about $5 US dollars - will buy you a cup of coffee in Harare...if they have any.

If they were purely mathematical, you might be able to anticipate price movements with computers and PhDs in math. Many have tried it. As far as we know, none has ever really succeeded.

It's not a mechanical system either. When prices go down, there are no screws you can tighten...no levers you can pull... Nor can you add more fuel or slather on more grease. It's not that simple.

Instead, markets are complex natural systems. Like mistresses, they can be jiggled and jived... but they can never really be controlled or predicted. That's what makes them so interesting, of course.

The markets are always teaching us...always correcting us...always giving us a kick in the pants. These are moral lessons...in the broad sense. That is, if you do the wrong thing you get punished for it. Step on a rake; it hits you in the face.

The purpose of a bear market is to correct the errors of the preceding boom. Most prominent among those errors is to think you can make money by speculating in the stock market. When this idea takes hold, good sense goes out the window. People will buy dotcoms with no business plans...and house builders at 40 times earnings!

But that's how we'll know when the correction is over - when people give up on the stock market...when they want nothing more to do with it. Judging by today's news...we're still a long way from there.

Get ready for another crash...the next leg down of this historic correction...the next kick in the pants...the next moral lesson.

If investors have learned nothing so far...neither have the feds. All over the world they're trying to solve a problem caused by too much credit by providing more credit. Trillions' worth, in fact...

We see the result of it in China...a country where the feds have money to spend...and the power to tell bankers what to do. The markets have gone wild...

In the United States and Britain, they've been less successful. But they haven't given up. On the contrary...they've put at risk an amount equal to nearly twice the GDP of the entire US economy...and now they're talking about Stimulus II...

Then Stimulus III...then Stimulus IV will probably follow...until the whole thing finally explodes in a blaze of glory...

Consumers have wised up. They seem to have learned their lesson. Savings rates have gone from zero to 7% in the past 12 months - a remarkable turnaround. Frugality is back in fashion. Thrift has been put back in the dictionary. Consumers are tired of carrying huge debt loads. They're eager to get rid of them as soon as they can.

But neither Wall Street, nor Washington, nor investors seemed to have learned much. Wall Street is still handing out billions in bonuses - leaving its firms short of capital reserves. Investors still seem ready to jump onto whatever wagon has the most other people on it. And while the private sector ran up trillions in debt in the bubble years; now, it's the public sector's turn.

In 1991, borrowing by government and the private sector put together was less than 5% of GDP. But by 1998, the private sector was on a binge. Every year for the following decade, households and businesses borrowed between 10% and 15% of GDP, while government continued to borrow modest amounts...less than 5% of GDP.

In 2008, the positions reversed dramatically. Private sector borrowing collapsed to below zero - meaning, the private sector was is paying off debt, not accumulating more of it. The public sector, on the other hand, has come to the rescue with borrowings between 10% and 15% of GDP.

Of course, this is classic counter-cyclical stimulus. What the private sector giveth up on...the public sector taketh up like an unexploded hand grenade. The politicians are now pulling the pin...

Yes, dear reader, there are still lessons to be learned.

But wait...isn't counter-cyclical stimulus a good thing? Everyone says so. Without it, said Ben Bernanke, we might have entered a Second Great Depression. And we don't know...maybe he's right. The private sector is no longer borrowing and spending like it used to; now, the feds have to do it, right?

Where have you been, dear reader? That's not the way it works. The credit explosion in the bubble years didn't really make households richer - it made them poorer. That's why they're struggling to pay their bills now. And the credit explosion in the public sector now isn't going to make people richer either; it's going to make them poorer too. Soon, the United States will be struggling to pay its debts too.

That's the moral lesson: borrowing makes you poorer. Unless you're using the money to increase output, there's no economic health it in. In other words, if a factory sees an opportunity, it might borrow to expand. The extra output should produce enough profit to allow it to repay the loan...and come out ahead. But if you borrow to consume, at the end of the day you're poorer. That's the lesson of the Bubble Years. That's the lesson consumers need to learn every couple of generations. And now, they seem to have learned it. They remember that the economy ran hot in the bubble époque, but it didn't do them any good. And while the stimulus of that era did stimulate consumption, it was not genuine wealth building.

And now cometh the feds. They're borrowing and spending on a scale never before seen. The federal deficit is expected to come to $2 trillion this year. Trillion-dollar deficits are foreseen for the next 10 years. There seems to be no way out.

What the private sector took away - about $1.4 trillion of debt-induced spending - the public sector puts back. But will this spending produce any more real wealth than the private sector binge? Let's see...the news reports tell us they are using it to fix toilets in national parks...cut down pine trees in rural Tennessee...and bail out the bankers on Wall Street. Is this consumption or investment? If it is investment, is it wise investment? It's not enough to invest; you have to put money into projects that pay off...that pay dividends...projects that give you the cashflow to pay back the debt! Will federal spending for the stimulus/bailout projects do that?

Don't even wait for the answer, dear reader; you already know what it is.

Tomorrow...the vigilantes are back...the real showdown...

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Government Debt
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• Have the Feds Given the Economy a Miracle Drug?
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A recent example from the British press: One of the first lottery millionaires punched a plumber and ended up in court, says The Telegraph. Michael Antonucci won 2.8 million pounds in 1995. But he "blew his entire fortune," reported the paper last month. Now he's reduced to stiffing tradesmen. The amount in dispute was just 400 pounds, what he was billed for a "gigantic ceiling mirror fitted above a whirlpool Jacuzzi." He had the mirror installed when he was still flush. Now that he's broke, he can't pay...hence the altercation.

The phenomenon is little different when it happens on a national or even imperial scale. Any money that you don't earn is stimulus. Without the sweat of honest toil on it, money seems to play a pernicious role in history. There are no examples - none - where it produced genuine prosperity. Instead, when a nation suddenly runs into some easy cash, it is soon spending more than it can afford...and getting into trouble.

The Roman Empire is in some measure a stimulus story. It conquered. It grew. Each conquest brought more booty...gold, silver, land and slaves. And each led to more conquests, which brought forth more booty. But the stimulus of this booty stimulated only the need for more stimulus. It did not stimulate real prosperity. Instead, it undermined it. First, slaves bought by rich landowners destroyed the free labor market and ruined small farmers. And then, imported wheat from the provinces - paid as tribute - put the large-scale farmers out of business too. Italy was then dependent on foreigners for its food.

In the first century AD, Roman conquests reached the point of diminishing returns; the stimulus came to an end. But borders still had to be protected. And Roman mobs, made up of displaced small landowners and out-of-work laborers, needed bread and circuses which drained the Treasury.

The first financial crisis of the imperial period came early. Caesar Augustus tried to solve it...with more stimulus. Neither paper money nor the printing press had yet been invented. So, Augustus increased the money supply in the only way he could; he ordered slaves in the silver mines in Spain and France to work around the clock! This extra money did not bring prosperity; it caused price inflation. In a period of about three decades, Rome's consumer price index almost doubled. Then, when output from the mines could be increased no further, Augustus's great nephew, Nero, found a new source of stimulus; he reduced the silver content of the coins. This source of stimulus proved ineffective, but enduring. By the time barbarians took over, the silver denarius contained almost no silver at all. Of course, Rome itself was played out too.

Another early and dramatic example of stimulus-in-action came in Spain in the 16th century. The conquistadors increased their supply of money in the time-honored fashion - by stealing it. Galleons brought treasure from the Americas; increasing the Spanish money supply substantially and fatally. The Spaniards had so much stimulus that they laid down their tools. Why should they work? They could buy things.

The discovery of a whole mountain of silver - Potosi - in the middle of the 16th century insured a supply of stimulus that would last for nearly a century. Results? Predictable. Inflation. In the "price revolution" from 1540 to 1640 the cost of living went up throughout Europe. In England, for which we have the most reliable data, prices went up 700%. And Spain, though it covered 40% of its state budget with this easy cash, still defaulted on its debts about once every 15-20 years, from 1557 for the next 10 decades. Spain, like Rome, welcomed stimulus; it never recovered from it.

Now we turn to the biggest misadventure in stimulus ever - the period after the United States 'closed the gold window' in 1971. In the 150 years before then, nations could stimulate their own economies with cash and credit, but only to a point. They could overspend; but they had to settle up in gold. After 1971, on the other hand, the sky was the limit - especially in the United States of America. The US could settle its bills in paper, which was then used by foreign central banks as monetary reserves. Since foreign banks were eager to add to their supplies of reserves, there was no effective limit on the amount of stimulus available. The Fed's adjusted monetary base grew 900% since 1985, and more than doubled this year alone. Total US debt tripled - as percent of GDP.

As it did with Rome and Spain, more and more stimulus stimulated spending and speculation, but not real output. During the 2001-2007 period, for example, credit in the United States increased by $22 trillion. The nation's GDP increased only by $4 trillion. For every extra dollar of output, Americans took on $5.50 of debt.

But now the bubble has blown up; the feds are on the case. What do they offer? More stimulus! Cometh a report this week that $23 trillion has already been put at risk in the various bailouts and credit guarantees. As for the US public debt, it is expected to increase until the country goes broke.

Future economic historians will look at these staggering efforts with awe and wonder; they will wonder what the Hell we were thinking.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• No Modern Government Policy is So Stupid that the Romans Didn’t Think of it First
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The subprime collapse is one symptom of years of little regulation, under-taxing, overspending, and massive debt. One way to understand what is happening in the United States is to look at what occurred time and again in Latin America and Asia, hotbeds of financial and banking crises. What we are living through happened time and again in Brazil, Argentina, and Mexico, as well as Korea and Thailand.

If there is too much debt, people lose confidence in the banks, then credit markets, currency, and government.

For more than a decade, the international financial cop, the International Monetary Fund, forecast a hurricane was heading toward US shores. As did many heads of the Treasury and the Fed. It is, to paraphrase a great writer, a chronicle of an agony foretold. There are five basic drivers of these crises, all based on excess: high income concentration, too much debt, too much reliance on foreign money, not enough tax revenue, and reckless government spending. Time after time governments believe they are different. They are bombarded by warnings but ignore, postpone, spend even more, and crash.

Over past decades, most US wages have fared poorly. Despite stagnant wages, consumer spending and debt increased, fueled by cheap credit. Companies also went on a debt binge. Careless deregulation allowed financial cowboys to run the system. Responsible CEOs who kept some cash, maintained moderate debt, invested for the long term, got pink slips. Financial chop shops did leveraged buyouts using a company's own cash and credit. To survive, companies piled on debt.

Many politicians decided reelection depended on cutting taxes and offering more benefits. Increase Medicare, postpone Social Security reform, hire more bureaucrats, and pay for a two-front war. Debt grew to pay for this party. These were not true tax cuts, just postponed debt; now we owe more and the bill has come due with interest.

Complicating this crisis is US economic hegemony. There were few places to park a lot of money. Despite the euro, European policies on debts and deficits are not much to brag about. So foreigners have gorged on US debt. The United States continues importing more than it exports. Middle Easterners and Asians who save and invest bought dollars for decades, but some of this money is now fleeing. The dollar has dropped sharply. Gold and oil have skyrocketed. In financial crises, huge pools of capital cross borders very quickly; a few can make a great deal of money shorting the country's currency.

The United States requires a massive restructuring to address its debt, cutting back on its borrowing, spending, and wars. The bailout package is essential to keep the credit markets open. But absent sentences that include the word austerity all the bailout will accomplish is a temporary postponement. Bailout and stimulus are a stopgap.

A solution requires the country to begin to spend what it earns, reduce its mountainous debt, and address massive liabilities, restructure Social Security, pension deficits, military, and Medicare. No wonder politicians would rather spend more of your money now rather than address these problems. Because we have been spending 5 to 7 percent more each year than we earn, a forced restructuring, triggered by a currency collapse, would have the same effect on wages and purchasing power that the housing collapse had on housing prices. So let's learn from our Latin and Asian friends and act before it is too late.

Regards,

Juan Enriquez and Jorge Dominguez
for The Daily Reckoning Australia

• Latin America Has Suddenly Become Very Interesting
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Let's begin with the stimulus/bailout/boondoggle/BS plan. As anticipated, it has failed. That is, the economy is getting worse, not better. It has failed the test set for it by its own creators. Back when the Obama Team was arguing for a big bailout bill, it warned that without a bailout, unemployment would rise above 8% in 2009. 'Pass this bill today,' said Ben Bernanke, or words to that effect, 'or there may not be a tomorrow for the US economy.'

Congress dutifully bent its back to the task of adding boondoggles to the bill and then okayed the measure. And here we are, in the middle of 2009, and the unemployment rate is already at 9.4%.

Even at the time, it was obvious that the hacks in the administration had no idea what was going on. They were just guessing about the economy and taking advantage of the situation to pass out more money that taxpayers hadn't even earned yet.

As predicted, the spending didn't make the situation better; if anything, it probably made it worse - by delaying the process of destruction, and hence retarding the process of creative reconstruction too.

We recall our other forecast too: when the bailout doesn't work, they'll pass another one. And so, in yesterday's New York Times, there is David Leonhardt urging the pols to even bigger acts of absurdity:

"The economy really may need more help," he says.

Yes, it will need more help. Especially if it keeps getting the kind of help it's been getting.

The stock market is acting more or less as we thought it would too. The big bounce began on the 9th of March. It's been almost four months now...and the bounce should be getting near its peak...and beginning to fall again. Just look at a chart of the Dow since March. You'll see exactly that. Like a cannonball, it went up...and now it seems to be arching over for its fall to the ground.

Yesterday, the markets seemed to hang in mid air... The Dow was up 57. Oil stayed at $69. Only gold seemed to know where it was going - rising $13.

Bill Bonner
for The Daily Reckoning Australia

• If the US Economy is Really Following Japan Things Will Get a Lot Worse
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The first of which believe that the banks are still in trouble and need to be nationalized. (Roubini, Krugman)

The second school of thought thinks that the banks are still in trouble, but that a public/private partnership can recapitalize them as they work their way out of the hole. (Geithner, Gross)

As usual, we play hooky. Here at The Daily Reckoning, we're not in either school.

In our view, the banks are in trouble because they lent too much money to too many people who couldn't pay it back. They should take the verdict of the market...and hang.

Hey...won't this cause a depression?

Ah...here is where we really part company with our fellow bipeds. We in a minority...such a small minority that all its adherents put together could probably fit into an elevator. Because we believe that a depression is just what America needs...and what it's going to get regardless of what the meddlers do. In fact, we think they will turn an ordinary depression into a great one. Or maybe even a "greater depression," as our old friend Doug Casey puts it.

Stocks barely moved on Friday. The Dow lost 15 points. Oil lost $1.76. Gold and the dollar moved little - the former up, the latter down.

California demonstrates what has to happen in an honest slump. They're preparing for "deep cuts" in school budgets, say the papers. Naturally, the education lobby is howling. But most of the money spent on 'education' is wasted anyway. Cutting back might even help kids learn something.

Consumers are cutting back too. That's probably the most important new trend to come with the post-Bubble era. Consumers are thinking small...smaller houses, smaller utility bills, smaller cars, smaller debts, smaller retirements.

That's a change that's likely to stick. They've seen where thinking big got them. Now, small is beautiful.

Forgive us for repeating ourselves; but this is important. The main source of economic growth over the past 25 years was consumers' willingness to go into debt to buy things. This spurred industries in Asia to marvelous feats of production. In the United States, it caused a big increase in corporate profits. You see; labor is industry's biggest expense. Taken all together, U.S. companies pay U.S. employees who buy the goods and services their employers produce. So, businesses have the revenue from selling to employees on the right side of the ledger and the cost of paying wages on the left.

But when employees began to buy more on credit, it was like a bartender who never asked customers to pay up. The companies had more revenue than ever. But they had no offsetting labor cost. Employees were spending money they never earned, so the extra sales went to the bottom-line as profit.

Earnings rose on Wall Street over the last quarter century as customers went further and further into debt. The companies selling credit - the finance industry - did especially well. And now its payback time. The bartender wants his money! Earnings and sales are falling as customers try to get out of debt. They collect the same wages - for a while - and cut back on spending.

Consumers are saving more and spending less. This is a good thing for the individual consumer. But it is a bad thing to the economists who believe in consumer-led GDP growth.

In fact, says The Richebacher Letter's Rob Parenteau, "Total U.S. retail sales have rolled back to levels we haven't seen since 2005."

"The freeze in consumer spending and the consumer economy could actually take many more years to thaw."

All of a sudden, the consumer is acting as though he had some sense. Naturally, government officials are determined to put a stop to it.

More banks were shut down last week. Banks go bust all the time. Nobody particularly cares. But some banks are said to be "too big to fail." If they go down, people believe, they take the whole economy with them.

So the feds step in...either to nationalize the big banks...or to subsidize them. This, we are told, avoids worse damage.

Does it? How? If a bank has made a bad loan, there is a real loss of capital. Money has been spent - perhaps on concrete...perhaps on software...maybe on champagne. It's not coming back. But, then come the bailouts. The people who made the mistakes are given an opportunity to make more of them - by the same people who were looking over their shoulders when they made the first ones. What exactly happens to the money they receive is a matter of hot dispute. Some goes to pay the bankers' bonuses. Some goes to pay their health spa fees and some gets lent out - in loans that are either better or worse than those that got them into trouble.

None of this corrects the mistakes. Depression is a natural thing. In our lexicon, it is the end of a major credit expansion. It is the point in the economic cycle when it becomes clear that many of the things for which credit was used were not good uses of money. The losses, mistakes and bad investment positions need to be recognized, worked out and written off. It takes time. And it is painful. But like dentistry, it is sometimes necessary.

You can paint a rotten tooth white and pretend you've fixed it. And there are a lot of people ready with a paintbrush. But that won't stop the pain. Better to yank it out...and get on with it.

As consumers stop spending, business sales and earnings fall...and so does employment. The unemployment rate is now over 10% in more than a quarter of the states. It's sure to get worse. By the end of the year, it should be over 10% nationwide. As people lose jobs, they begin to think even smaller. Las Vegas holiday? Forget it! New car? Not without a subsidy; otherwise, we'll stick clunker. Go out for dinner? Nah...let's stay at home...and we'll plant a garden too!

Welcome to a depression. Not such a bad thing, really. Just a period of adjustment...a time for fixing, re-organizing, downsizing, and mending. There's a time to every purpose under heaven. This is the time to take stock and shape up.

But wait again. It doesn't FEEL like a depression. Where are the soup lines? Where are the Okies packing up and moving to California? Where are Ziegfield Girls, the Civilian Conservation Corps and Eleanor Roosevelt? How come this depression's not in black and white?

Well...because this is a 21st century depression. This depression is in living color...and it comes to a world that is much richer than the world of the 1930s. Besides, it is just 1930...not 1932. Give it time.

Capital & Crisis' Chris Mayer is calling it the 'Great Depression 2.0' - and he's created a "Wealth Recovery Program" for his readers to help answer any questions they may have about the downturn.

A note on the banking system from Strategic Short Report's Dan Amoss:

"The popular narrative is that that the financial crisis was a failure of the free market, but this narrative glosses over the fact that banking is far, far from a free market," writes Dan.

"The banking system hasn't been subject to free market discipline for decades, and it's still not. Case in point: Bank bondholders and shareholders were bailed out - at taxpayer expense - from the consequences of their poor lending and investing decisions.

"Banks are supposed to be intermediaries between savers and borrowers, allocating credit in a manner at prices (interest rates) in line with default risk. But they largely failed in this role. Most banks - especially the 'too big to fail' banks - did a horrifically poor job of pricing credit risk at the peak of the credit bubble. Credit spreads were ultra low in early 2007, when it was one of the riskiest times in history to be making loans.

"How did the banking system make such colossal errors in judgment about credit risk? Interest rates were sending a distorted signal about credit risk; all you needed to do was follow the new credit back to its ultimate source and ask the right questions about the connections (or lack thereof) between saver and borrower. One would think thousands upon thousands of federal banking regulators - and those responsible for designing our financial regulations - would have the resources at their disposal to identify the structural weaknesses in our financial system.

"Unfortunately, instead of providing a road map to designing a system that connects savers with borrowers in a more sane, responsible manner, it looks like the proposed banking reforms will give us more of the same. Such economic power concentrated in the hands of banks not subject to enough free market discipline is a problem, and the real economy will likely suffer from it."

And here's the latest from Argentina. The country faces a financial crisis with elections only a week away. Nestor Kirchner, husband of the present president, is running against a man who seems to know a lot about money. Francisco de Narvaez increased his own wealth 900% in the four years 2004-2008. How did he do that? Well...that's what everyone wants to know. De Narvaez has been accused of drug dealing...but so far nothing has been proved.

We turn again to Argentina to try to understand how financial crises work. Studying major financial crises in America requires too much patience...and remarkable longevity. The last depression in the United States was in the '30s. And you'd have to go back to the War Between the States to find currency troubles anywhere near to those Argentina suffered in the last 25 years.

"Argentina has a financial crisis about once every 10 years," say the locals. "And each crisis lasts about 10 years."

If you had 100 billion pesos in 1983, you would have been a very rich man. And if you had held onto your pesos for ten years...at the end of the period you'd have just enough money to buy a cup of coffee. Then, in order to prevent further inflation, the American-advised Menem government started linking the peso to the dollar. One peso = one dollar. End of story? Not exactly. Since it had solved its currency crisis, the Menem government could borrow money again (people didn't have to worry about the inflation risk.) It barely hesitated. It borrowed heavily - though not as heavily as the US currently - and soon ran into more trouble. Then, in the early 2000s, another crisis struck. If you'd held your coffee money for the whole decade '93-'03, you got a shock at the end of it. The Argentine government froze your bank account and devalued the peso by 2/3rds.

You'd have to go back to the Roosevelt administration to find a similar episode in the United States. The New Dealers reshuffled the deck, just like the Peronists would do on the pampas seven decades later. Team Roosevelt closed the banks, seized the gold, and then devalued America's money - again, by about 2/3rds.

The up-coming election in Argentina could go either way, we are told. One poll puts Kirchner ahead by 10 points. Another puts him behind by 5 points. And who knows what will come out in the news!

Bill Bonner
for The Daily Reckoning Australia

• Kirchners Lose Election in Argentina
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• Admonishment from China and the Decline of U.S. Credibility
• Austerity is Missing from the Financial Bailout Debate
• There Are Two Ways of Studying Economic Theory

Everybody who's anybody in this country, it seems, gets a permanent, pet government program, if not a large bailout. (Huh? You didn't get your program or bailout?) How long can it last? I think we're about to find out.

As Bernie Madoff might say, "Bailout, schmailout." Still, the axis of overspending leads to inflation. It's the 1970s redux. And inflation will soon rear its head and roar so loud that even the wizards of Washington will have to admit the obvious.

Actually, our betters in Washington are waking up to the issue of inflation and the decline of the dollar. Just yesterday, I received an inquiry asking if I want to appear on a nationally syndicated show that originates from Washington, D.C. (well, Alexandria, Va., to be exact). The audience is Washington people - you know the type - and their intellectual and spiritual kin in "blue spots" across the country.

Here's the exact inquiry:

"We're doing a story on hoarding behavior and I am looking for people who have taken some (or all) of their savings out of traditional investments and are now storing money as cash or in the form of physical gold or some other precious metal in a safe or secret place. I am having trouble finding anyone like this. Do any of you know of someone who fits this description, who might be willing to talk to me about it? I am looking for someone in Boston; Washington, D.C.; New York; or maybe Chicago. If anyone has any leads, please let me know!"

Oh, man! That's rich! Verbatim! Honest to God, I have not edited this inquiry by EVEN ONE WORD! These people are clueless!

The producer wants to interview gold bugs for the show. In an anthropological fashion that would do Margaret Mead proud, the subject of the story is "hoarding behavior." But the poor producer says, "I am having trouble finding anyone like this." (Like looking for a registered Republican at the Harvard Faculty Club?) And how about that request to find somebody in Boston, Washington, New York or Chicago? If you're from, say, the silver mining town of Wallace, Idaho, you need not apply.

Here was my reply: "People who've taken their savings out to buy gold and store it or hide it probably don't want to brag about it on NPR."

Remember that line from the movie Apollo 13? "Houston, we have a problem."

Wow. Do we have a problem in this country, or WHAT? It's WORSE than Apollo 13. We should be so lucky as to be in a small capsule in the cold of space heading away from Earth toward the moon with almost no oxygen or electrical power. Instead, we're watching the national currency declining and dying right before our eyes. And the opinion makers of the nation don't know anybody who owns gold. Amazing!

Well, the producer could always go find somebody in Dubai. Because from that distant desert kingdom comes word that the Dubai Multi Commodities Centre (DMCC) has finished building a state-of-the-art precious metals vault, with world-class tracking and security systems. Think Fort Knox, but in the desert and without the trees and pretty landscaping we see in the hills of Kentucky.

You want "hoarding behavior"? The new vault will become the home for the exchange-traded fund (ETF) of Dubai Gold Securities. Also, "It's a natural home for the central banks in the region to store their gold in Dubai, rather than in London, where they have typically held their gold," said a Dubai-based gold dealer INTL Commodities DMCC's CEO Jeffrey Rhodes. Yep. "Natural home." (Margaret Mead, call your office!)

A DMCC official stated that the new vault will be used to store precious metals associated with precious metal-based ETFs that are on the drawing boards and scheduled for launch later in 2009. This can only add to worldwide demand for gold and silver, especially from the traditionally gold-friendly Middle East.

OK, so here's the bottom line. When the American people realize that the dollar is in for another round of inflation, they're going to look for a way out. When people envision the future decline in their purchasing power, we'll see a rush for the monetary exits. It'll be the "Gold Panic" of 2009, or 2010 or 2011... Whichever year gets the naming rights.

When the reality sinks in, people will flock in droves to physical precious metals (yeah, try to get some!), as well as mining shares. I'm old enough to remember the last time it happened, in the 1970s and early 1980s. And I've studied enough history to know it won't be pretty.

So beat the gold rush! Hoard now!

Until next we meet,

Byron W. King
for The Daily Reckoning Australia

• From the Gold Pan… Inflation, Deflation and Precious Metals
• The Precious Metals Gang Gathers
• Arab Wealth Pours Back into Dubai
• Feds’ Attempt to Bail Out Consumers with Tax Rebates
• Gold and Silver!

The bear market rally, that is? The Dow was down again yesterday...but just a little...52 points.

The short-covering rally is finished, says David Rosenberg, formerly one of Merrill's top analysts.

"Everyone I know is laying people off...cutting back...and generally struggling to survive," said a colleague from Florida. "I don't believe this recovery story. The stock market might be up, but the real economy is still sinking."

Yesterday, we went to get our teeth checked out.

"Hey...I'm a Daily Reckoning reader," said our dentist. "So, I knew you were in town."

Asked about the state of the economy, he had this comment:

"Our business is a little counter-cyclical. People get laid off from work, but they still have their health benefits - at least for a while. They want to make use of them while they can. And they've got the time to do it. So, our business actually goes up.

"But then, when the recovery comes they go back to work...they're busy...and they've already had their teeth fixed. We're not seeing that yet."

House prices are still falling. The average house in Southern California has fallen to $247,000 - a big drop from the top set two years ago. Toll Bros., one of the country's biggest builders, reports revenues down 51%.

If the US economy is really following Japan, things are going to get a lot worse. Japan's output is collapsing - at a 15% annual rate last quarter. The Land of the Rising Sun is a major exporter. For the first time ever, exports are falling...taking the Japanese economy down with it.

Internally, the Japanese are still not big spenders. The population is not only aging...it's shrinking. That's not happening in the United States. Thanks largely to its immigrants and Hispanics, the US population is expanding. But this new population is not the same as the old one. At the top of the socio-economic pyramid in the United States is a huge group of aging, mostly white baby boomers. Naturally, the geezers vote. And naturally, they vote themselves more benefits at the expense of the next generation.

In fact, you can look at the entire bailout/stimulus program...and the $1.8 trillion US budget deficit for 2009...as a huge transfer of wealth. Benefits are provided to the present generation at the expense of the next generation. The white boomers borrow - through their elected federal representatives. The next generation - much more Hispanic and much more immigrant - is stuck with the bill.

But it's not that simple.

The bailout/stimulus program is a scam on top of a scam. One generation may be trying to get something at the expense of the next - but they're both losing. On the surface, the next generation gets stuck with the cost of bailing out the present generation. But underneath, the bailout is a sham; it doesn't really work. It doesn't revive the economy. All it does is move money from sensible households and good businesses to reckless spenders, mis-managed firms, and foolish projects. The losers are the winners.

What it doesn't do is bring about a general recovery in the economy. It can't - for all the many reasons we've described in these Daily Reckonings.

The feds can spend money. But they can't turn bad investments into good ones...nor turn hopeless, brain-dead companies into successful ones...nor erase $20 trillion of excess debt.

All the feds can do, in other words, is make a bad situation worse.

First, they mislead investors into believing the fix is in. With all that money coming into the market, people think the problems are going away. "Everything is under control," they say to themselves. Then, they put their money into stocks, deluding themselves that a new boom is underway. Later, when it becomes clear that the boom is a long way off, they are deeply disappointed. Stocks fall...and the economy enters a long, dark period of workouts, defaults, bankruptcies, disgrace and suicides.

Then, as we have explained many times, the feds' money actually delays the process of creative destruction. Instead of burning off the dead wood and making room for new growth, the smoke jumpers at the Fed parachute out of airplanes to smother the flames. Instead of a hot fire that burns itself out in 24 months...the economy suffers a slow burn for 10 years.

Another way they make the situation worse is by undermining the rule of law and the predictability of economic rules. When a corporation goes broke BOTH the bondholders and the stockholders should suffer. But in bumbles the Federal government with bailout money. The share price plummets as investors anticipate a clumsy takeover - wiping out the shareholders. But the bonds could even go up - as the firm is given easy credit, allowing it to stay out of bankruptcy and continue paying off the bondholders.

Worse, as in the case of the Chrysler bailout, the feds jumped in and upset everybody. Instead of letting the markets sort out the stockholders and bondholders, they forced a political settlement that rewarded one class and punished another. Bondholders got less than they should have...and the autoworkers union got more.

What is this? A free-market country with the rule of law? Or a third- world basket case in which the politicians decide who gets what?

Bill Bonner
for The Daily Reckoning Australia

• No Evidence of Recovery as Unemployment Getting Worse
• The Economy is Getting Worse Not Better
• If the Economy is Not Recovering It Isn’t Getting Enough Stimulus
• GM Insolvency Can’t be Run-of-the-mill
• Is the Real Economy Growing, Expanding, and Making Money?

Does this describe your journey with gold?

Although gold's had a good run, rising from a monthly average of $760.86/oz in November 2008 to $943.16/oz in February 2009, when will it take off? That's still going to happen, right?

Wimpy, Popeye's burger-loving pal, was always looking to get what he wanted today with a promise to pay tomorrow. Sound familiar?

In their thrashing attempts to get their economies going again, governments around the world have pounded interest rates into the floor and flooded their banking systems with liquidity. Take a look at the monetary actions from the G7:

Interest rates are at historic lows, an artifact of the robust, worldwide efforts to debase currencies. M2, one measure of money supply, is up in all G7 countries, which signals that tomorrow's inflation is being baked in the cake today.

Further, bailout numero dos, with a rich pork filling, has been signed, sealed, and is about to be delivered, including an endowment for a "bad bank" that will buy up the loans that troubled commercial banks would like to deny they ever made. In addition, it guarantees hundreds of billions of dollars in bank assets - all on top of bailout numero uno. And don't forget the estimated $493 billion the Treasury Department will have borrowed by the end of the first quarter 2008; that on top of $569 billion the government borrowed in Q408, an unprecedented amount for any quarter, ever.

The word "unprecedented" seems too weak to convey just how much money is being printed and/or borrowed to buy off the recession. So, when will all this money start showing up as higher prices at the supermarket and shopping mall? And when will gold react to this bumper crop of paper?

The historical record indicates that a surge in money growth has its peak effect on economic activity about 9 to 18 months later. Add another 12 months or so for the peak effect on consumer price inflation. In other words, the Federal Reserve is always driving with a loose steering wheel. Most of the experience behind those numbers is with relatively tame ups and downs in the business cycle - not the kind of financial violence we've been seeing lately - which adds another variable. And on top of that, the numbers are about peak effect, not initial effect.

So the timing remains uncertain. But what we do know is that there are clear and unavoidable consequences to wildly energetic money creation, including, sooner or later, rampant price inflation.

We're beginning to see interest in gold from the mainstream, which is encouraging. And enthusiasm from the general investing public will be what ultimately sends gold to the moon. Here's what we've observed over the past 30 days:

1. A number of mainstream economists and fund managers are openly expressing interest in gold. "The government can print endless money, but they cannot increase the supply of gold," said Michael Pento, chief economist at Delta Global Advisors Inc. "Anything the government cannot replicate by decree, I want to own." The firm, with $1.5 billion in assets, is doubling its gold holdings to 8%. We saw very little of this six months ago.

2. The mining industry has recovered its ability to raise capital. Take a look at the recent financings for some gold companies:

• Newmont $1.2 billion
• Newcrest $476 million
• Kinross Gold $414 million
• Agnico-Eagle $290 million
• Red Back Mining $150 million

Compare this to the financial woes we hear continually about banks, brokerages, and government agencies. The only capital they can attract is government handouts.

3. While there are much better ways to turn gold into cash, Cash4Gold (who advertised during the Super Bowl) and similar businesses bombarding the airwaves with their pitches have sensitized the public to the topic of gold. Expect the interest in the yellow metal - and its price - to increase in a serious way.

4. January's Cambridge House Investment Conference in Vancouver was well attended, with the second day setting a record. Every session was packed, standing-room-only for most speakers, including Casey Research's Louis James and Marin Katusa.

While no one was emphatic about the timing, most speakers agreed that at some point gold will be sought as a safe haven by the masses, who will catapult the price to new highs. Here is a quote from John Embry, chief investment strategist, Sprott Asset Management:

"The average retail investor has little or no investment in gold and no understanding of how important it will be. The year 2009 will be volatile, but volatility is a small price to pay for where gold is headed. An explosion in gold and silver is inevitable in the years to come."

The overriding theme was clear: Gold is going up. Period. It may or may not happen as quickly as you want, but the recent range trading hasn't defused its explosive potential.

So when will gold take off? The signal won't be inflows to ETFs (although they are indicators), or jewelry sales (the '70s bull market had nothing to do with bracelets), or even sales of physical bullion (we had that in '08 and gold was up 5.5%, hardly meteoric). No, the payday rise in gold will occur when there is a significant shift in the psychology of the general public.

And whether the glory days are just months from now or a year or two away, it's clear that the oasis is real and lies ahead. Is your cup ready?

Regards,

Jeff Clark
for The Daily Reckoning Australia

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