The Dow fell 67 points on Friday. Investors began to wonder if the news coming from the banks was as good as the first reports indicated.

For example, the Bank of America reported losing a billion dollars on its consumer accounts. It is all very well for JPMorgan and Goldman to make money. They're investment banks. And they're making money thanks to the US government's generous bailouts. They pay almost nothing for borrowed funds...in dollars, of course. And then they take the money and bet against the dollar. So far, those bets are doing pretty well.

Meanwhile, the Bank of America is a real bank. With real mom and pop customers. And the poor moms and the poor pops are going bust. They can't pay their bills. Or, at least so many of them can't pay their bills that it cost BoA $1 billion in loans write-offs.

The LA Times reports that "California job losses keep climbing." The unemployment in LA county has reached 12.7%.

Also, from LA comes news that millions of square feet of office space remain vacant. Between LA county, Orange county, and the Inland Empire, there are some 51 million square feet of empty offices.

We don't know who owns all this vacant space. But we can imagine who lent the money to build it - the big banks.

But lending money to customers is a tough way to earn a living. The more you lend, the more you make...until you lend too much. Then, you don't make anything.

Of course, speculating is a tough business too. But it's a lot easier when you can borrow from the feds at practically zero interest and the government also guarantees your debts. How can you lose?

Don't worry, dear reader. Bankers will find a way. They always do. Want an investment strategy that really works? Just figure out what the big banks are doing and do the opposite.

What are the big banks doing now? Mortgage lending? Nope. Credit cards? Nope. Business expansion? Are you kidding? How about mergers & acquisitions? Not really.

According to the news reports, the banks are making money by "trading." Trading what? Trading the dollar for things that are going up.

Look at the price of oil - over $79. And the price of gold - over $1050. Compared to each other - oil and gold - prices are stable. But against the dollar both are rising. In other words, people with dollars are trading them for oil and gold.

And not just oil and gold. While US stocks have gone up 50% or so in the last 7 months, emerging markets are up twice as much. Argentine stocks - who would have believed it? - have doubled. Indian stocks are up about 80%.

Well, let's see... If the big banks are getting rid of dollars... Hmmmm... Do we want to get rid of dollars, too? Maybe not quite yet. When speculators unwind all these short dollar/long oil, gold, stocks positions it will send the dollar flying.

Could the dollar surprise the speculators? Yes it could. This weekend Tim Geithner told the world that the "US must live within its means." There was no word on how his audience reacted. Surely some of his listeners must have giggled. Maybe at least one guffawed. A few must have rolled their eyes. Here was the man in charge of the Treasury of the world's biggest spendthrift. The papers announced this weekend that his deficit had reached a new record, over $1.4 trillion.

In other words, no nation ever lived as far beyond its means as the US.

In the 10 years, '97 to '07, consumers lived beyond their means. Then, suddenly, the shock of '07-'08 brought consumers to their senses. Now, they're saving...now it's the government that is living beyond its means.

The New York Times tells us that the turnaround in household accounts has been breathtaking. This year, the average household is expected to SAVE $4,643.

As usual, the NYT misses the point all together. It asks whether this is good for the economy and comes to the predictable conclusion that it is not. If consumers don't spend, the consumer economy won't grow.

At least you know, dear reader, what nonsense this is. An economy only appears to grow from consumer spending. When consumers spend money - especially when it's money they never earned - it triggers a phony boom. The economy gears up to produce more stuff. Then, when consumers have to repay their debts, the economy shrinks again. That is the story of the US economy 2001-2009.

A real boom, on the other hand, is one that results from increased earnings, not from debt. When people earn more they can spend more - without going further into debt and without having to stop in order to pay back the money they borrowed. But you don't get that kind of boom from consumer spending. You get it from saving money...which is then invested in new tools that increase output.

More output = more earnings = more spending power = real economic growth.

Simple enough, right?

But getting back to those savings...

If the average household saves $4,643 this year...that's about $500 billion savings for the entire nation. Yet, the US government is running a budget deficit of 3 times that amount.

Are we missing something or is that net dis-saving of about $1 trillion? In other words, the US is going deeper and deeper into debt. Whee!

Wait a minute. Didn't professors Reinhart and Rogoff just study nations that went too far into debt? And didn't it show that once you take on too much debt it is impossible to escape trouble? Don't governments always go broke when they borrow too much? And doesn't it always lead to crises - banking crises, credit crises, currency crises and political crises?

Yep.

Well, shouldn't we be running for shelter?

Yep.

Then, shouldn't we be dumping the dollar?

Yep.

But...it's not that simple. Markets always try to sucker in as much money as possible. Right now, people are afraid of the dollar. Just this weekend, the nations of Latin America began an initiative to create their own regional currency - the sucre - to compete with the dollar. And with gold and oil rising, many investors - especially the big banks - are betting heavily against the greenback.

Wouldn't it be just like Mr. Market to engineer a dollar rally...BEFORE we have a dollar collapse?

Yep.

Foreclosures are up 5% from the summer to the fall. Poor Donald Trump. Buyers of his condos in Miami are suing him. Prices have plummeted. Buyers think The Donald is at fault.

And poor Ted Turner is in the news too. He's down on his luck...and down to his last $2 billion. Jane is gone. So is CNN. He's struggling to "stay relevant," by working on women's rights issues and fighting global warming. And he's getting in tune with the times by downsizing:

"I've had the experience of being on top and riding the roller coaster down again, nearly to the bottom. You know, if you economize and don't buy new airplanes or long-range jets, or that sort of thing, you can get by on a billion or two."

And here's something interesting. Harrods is selling gold bars:

"From this morning, Harrods will start selling gold bullion and coins over the counter. In a sign that the credit crisis has left his gilded customer base largely untouched, Harrods owner Mohamed Fayed has teamed up with Produits Artistiques Métaux Précieux (PAMP), the Swiss refiner, to sell gold in the store. Aimed at private investors, the gold will be sold at the Harrods Bank branch on the lower ground floor of the West London store."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• In Europe, Banks Borrow Money and Lend it Back to the Government
• The Banks Should Hold More Capital
• Is the Real Economy Growing, Expanding, and Making Money?
• How to Buy Crude Oil for US$2 a Barrel
• Central Banker Hotline Still Waiting for its First Call

What was America's Golden Age?

It is much too soon to write the history of America's decline and fall. Still, that doesn't stop us from guessing.

We would name the period between the fall of the Berlin Wall and the fall of Lehman Bros - a period of only 19 years - as the peak of US power and wealth. Of course, Americans were dreaming during those years. The dreams were the usual imperial sort - that the US Empire was such a benefit to the rest of the world that the foreigners would support it indefinitely. Rome didn't take any chances; it forced its conquered nations to render tribute...slaves...gold...and wheat. The American empire depended on trade...and the dollar. As long as the United States had a commercial advantage, the empire was profitable. But as the 20th century aged, so did the US economy. Its competitors - notably Germany and Japan - had a big advantage. They had been bombed out in the '40s. They could build anew. America's trade advantage slipped away...and then its trade balance went negative in the mid- '80s. It has been getting more negative almost every year.

The trade losses shrank after the fall of the House of Lehman. Americans cut back. But today we get news that the trade deficit has just grown more than in any month in the last 10 years. Have Americans suddenly become big spenders again? Probably not. But we'll have to wait for another explanation; we don't have one.

No account of America's glory years - roughly the period between the reign of George Bush I and that of his son, George Bush II - would be complete without mention of the events that happened on this day eight years ago. A small group of terrorists pulled off an amazing coup - bringing down two of America's iconic buildings, right in the heart of New York City...and on primetime TV! Historians might be tempted to use this event as a milestone, marking the end of the period of maximum happiness in the United States of America. We caution against it. It was only later that it became apparent that the US reaction to the terrorist incident was suicidal. The nation desperately needed to bring its ambitions back in line with its means. It needed to save and invest in new factories and new infrastructure. Instead, it wasted trillions fighting phantoms and nobodies. But as far as anyone knew, US influence, prestige and power remained near its zenith throughout the wars on terror and Iraq.

The fall of Lehman changed things. Then it was obvious that not only was America vulnerable, she was an enemy to herself. She had diddle- daddled during the glory years, dawdling with the lion cubs that would grow up and maul her. Now, in the period we are living through, she attempts to go back to sleep and rerun her balmy dreams. That is what "recovery" is all about - a return to the land of nod and nonsense...in which people think they can actually become wealthier by squandering money they don't have on things they don't need.

Fortunately, as near as we can tell, most private citizens are now awake. A report at the beginning of this week showed that they repaid debt at a rate four times faster than economists projected. Savings rates are rising. Spending is falling. People are doing what they should do - they're cutting back.

But the feds continue their efforts to sabotage the correction and destroy the empire. They have already blown-up the budget - with $9 trillion in deficits expected over the next 10 years. Now, they're working on the dollar.

Yesterday, the dollar fell to $1.45 per euro. Gold remained just below the $1,000 an ounce mark. And the Dow rose 80 points.

Stock market investors seem to be looking forward to another big bull market. But with the economy deteriorating, they are probably just dreaming, too. Median household income fell 3.6% over the last 12 months. Of course, that's just what you'd expect in a correction. But it's not what the feds were hoping for. So, they're pulling out all the stops to try to turn it around. Most important, they're pulling out the stop that keeps the dollar from rolling down the hill.

But the dollar will eventually come tumbling down...and those who are holding gold are going to be sitting pretty. Gold is, after all, the ultimate store of wealth.

The empire sinks into the mud. Yes, this is the downhill period...the slide into corruption...the period in which Juvenal complained that Romans were only interested in 'bread and circuses.'

When you are on the board of a decent corporation, for example, if you have a direct financial interest in a matter under consideration you're expected to 'declare an interest' and absent yourself from the vote. But in a mature democracy, the most self-interested citizens are those most likely to vote. Currently, about 20 million people work for government. About 45 million receive Social Security benefits. About 34 million depend on food stamps.

(People who count on the government to feed them, warned Jefferson, "will soon want bread." That doesn't seem to worry many people. But at least the state of Maryland has an Orwellian sense of humor about it. People who depend on government for food are given "Independence" cards.)

That's 99 million people who have a direct interest in expanding government outlays...with some overlap, of course. And it doesn't mean that every person receiving a Social Security check is going to back the feds. But it doesn't count all the millions more who get subsidies, bailouts, welfare payments (often masquerading as tax credits), government contracts, and so forth, either.

Well, how many people does it take to win a national election? Obama won with 63 million votes.

The dollar's weakness hasn't been missed by it biggest foreign holder - China.

Reported earlier this week in the Telegraph:

"'We hope there will be a change in monetary policy as soon as they have positive growth again,' said Cheng Siwei...talking about America.

"'If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,' he said.

"China's reserves are more than - $2 trillion, the world's largest.

"Mr. Siwei continued: 'Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets,' he added."

Then, two days ago, in came a report that China is going to issue bonds of its own - in yuan.

This news is a shot across the bow of America's imperial currency. It signals that China is moving into position to eventually challenge the greenback. Investors will have another alternative to the dollar...another bond issued by another government and backed by another economy...maybe one that is on the way up, rather than on the way down.

Meanwhile, Americans grow poorer. Bloomberg reports:

"'The decline in incomes we're seeing certainly has implications for consumer spending, particularly post-housing bubble when families can't tap into home equity through loans,' said Heather Boushey, a senior economist at the Center for American Progress, a research organization headed by John Podesta, a leader of the Obama administration transition team.

"The poverty rate is likely to keep rising through 2012, even after the recession ends, adding to pressure on the Obama administration to enact a second economic stimulus package, said Isabel Sawhill, a senior fellow at the Brookings Institution in Washington, a policy research group.

"'We will likely have not only a jobless recovery but also a poverty- ridden recovery,' Sawhill said. 'The stimulus money is going to go away long before the poverty rate peaks.'"

How can a consumer economy grow when its consumers are becoming poorer? We take up that question below...

Bill Bonner
for The Daily Reckoning Australia

• America’s Decline as a Great Empire
• Economy Has to Grow at 1% to Stay Even With Population Growth
• America, An Empire You Can Trust?
• The Rise in the Dollar Doesn’t Have Everyone Convinced
• China and its Trade

We flew through the airport...got the express train. The whole thing took only a fraction of the time it takes us when we fly into Dulles at Washington.

But London was in a sour mood when we returned.

"Decade of pain predicted for public services," was the headline on Friday's Guardian from London. The reason for the decade of pain is the obvious one. Tax receipts are down - because of the depression. Governments are caught in a bind. Their revenues go down just as their costs - offering bailouts, counter-cyclical stimulus, and handouts to the unemployed - go up.

Ireland and California have been in the news on this subject. But they're hardly alone. It's a problem for almost all governments in the English-speaking world. As for the rest of the world, we don't know.

Ireland is facing its own decade of pain. So is California. This morning, California is in the news. Apparently, a deal has been worked out. The state will stay in business...and even pay off its IOUs. But it will mean cuts of 'services.' Here at The Daily Reckoning, whenever we modify the word 'services' with the word 'government' we feel we should warn readers that we don't really mean it. Most government services are a disservice...like a government-subsidized business they are a fraud on the economy, absorbing valuable resources in order to provide a 'service' that is worth less than the inputs that were required to provide it. The service is a disservice to the broader economy.

And today too we find that England is sinking deeper into depression; it too will have to endure a decade of painful honesty.

"UK Slump Identical to that of 1930s," says Saturday's headline in the TIMES.

A chart traces the decline...to minus 5.6% GDP growth over the past 12 months...paralleling the decline following the crash of '29.

"The collapse is Britain's economy now rivals the worst days of the Great Depression..." continues the report.

If it continues following along on the 1930s track, the UK economy will continue to decline...and bottom out at 7% or 8% below pre-crisis output. Then, it will bottom out over a period of a couple years before beginning a recovery, back to pre-crisis GDP levels.

If that's correct, we're only about 2/3rds through the depression in terms of output...and only about 1/3 in terms of time. Remember, the first leg of the Great Depression lasted 43 months. So far, this one is only 19 months old. It probably has a ways to go.

The stock market has a ways to go too. The Dow was up 23 points on Friday, bringing it to 9093. Like the economy, the stock market runs in long cycles - from bull to bear and back to bull again. The first post- war bull cycle took the Dow from under 100 to nearly 1,000 in 1966. Then, the index shilly-shallied around for the next 16 years. Adjusting for inflation, investors lost more than half their money during that period. Then began the big bull market that dominated our financial lives until 2007. But this bull market actually topped out in January 2000 - in real terms. Adjust for inflation and investors made nothing during the 2000-2007 period. So, the current bear market has been going on for nine years already. But if it lasts as long as the typical major bear market of the 20th century, about 18 years, that means it is only about half over. Look for it to end sometime between 2015 and 2020.

Where will the Dow be then? We can make a guess. If the economy were to lose, say, 10% of GDP...the loss in incremental sales would probably erase about 50% of corporate profits. And the financial industry, which had been responsible for 40% of corporate profits at its peak, will probably go back to a more reasonable figure of 10% of corporate profits - so that's a loss of 30%. Of course, there's some overlap on these figures - and a huge dose of Daily Dead reckoning - but maybe the loss of corporate earnings averages about 60%. So, if 2007 were a base of $100 in corporate earnings, we can expect only $40 sometime in the future.

The most important thing that happens in a bear market is that the multiples go down. Investors, who were prepared to pay $25 for a dollar's worth of earnings at the peak of the bull market begin to think they've been too optimistic. As the depression deepens they begin to see things differently. They see earnings continue to fall and feel they should be more cautious. So they take down p/e ratios...from 25 down to as low as 5. But let us say the p/e ratio goes to 8...on Dow earnings that are only 40% of what they were in 2007. Where would that put the bottom? Dow 1600. Allow for a little inflation...maybe 2,500.

Watch out...

Bill Bonner
for The Daily Reckoning Australia

• Every Major Bull Market Needs a Major Bear Market
• Investors Better Off Investing in Anything but Stocks
• The housing bubble caused big increases in nominal GDP
• The Profits Depression
• We Don’t Gamble on Stocks in a Depression

Bloomberg reported that "Wall Street's largest bond-trading firms say the worst may be over for investors..." Then, General Electric's CEO, Jeffrey Immelt and famous investor George Soros both said that the crisis is "behind us" and that growth will begin again next year. Finally, analyst John Dorfman opined that the stock market would be a safe place for their money at least through the end of the year.

And now comes the big American holiday - July 4th. Investors pack their suntan lotions and head off to the beach for Independence Day. With Jaws in a cage, they had judged it safe to go into the water. But then came Thursday's news. Instead of going down as predicted, the number of job losses for June went up. Another 467,000 people became unemployed last month. The figure even surprised us; we didn't think there were that many people who still had jobs.

And so...this weekend, investors walk along the beach deep in thought. Is it safe to go back into the water...or not? They should listen carefully. That gurgling sound they hear is not mermaids singing, it is the world economy, drowning.

As we reported in this space, the feds' bailouts, boondoggles and bankers' bonus plans aren't working. At the end of last year, they predicted unemployment over 8% in 2009 - if the stimulus plan were not enacted. But it was enacted. Unemployment is at 9.5% already and it is still rising. It will be over 10% before the end of the year. Global trade is collapsing; exports from Germany and Japan are down about 40% from a year before. Prices are going down too - with a report this Wednesday that the entire Eurozone has slipped into negative inflation. And from Britain came data showing a contraction of 2.4% in the first quarter, bringing the year-to-year decline to nearly 5%. "Economy shrinks at 1930s rates," said the headline in Wednesday's Telegraph.

When we look at America's employment numbers, we feel like a school doctor. We would call the authorities, except that it was the authorities who should be arrested. After the feds got finished with them, the numbers told of a better-than-expected drop in May U.S. payrolls. The key to this uplifting news was not a genuine improvement, but new and improved techniques in torture. Water-boarded with seasonal adjustments and birth/death models, the numbers began to see jobs everywhere. As for "discouraged workers", meaning those who gave up looking because they couldn't find a job, these unfortunate souls disappeared from the jobless figures altogether.

John William's Shadow Government Statistics reports that without these twists, the numbers tell the same story they've been telling all year - unemployment is still getting worse, at about the same pace as earlier in the year. "The unadjusted annual decline in May payrolls was the worst since May 1958," says Williams. And if they were allowed to speak freely - as they did in the '30s - the figures would show real unemployment at over 20% of the workforce...or about 30 million people. That approaches Great Depression levels...and we're still only in 1930, not 1932. As for those still working, an additional 1.5 million U.S. workers have been "forced into part time work" according to the Financial Times.

Analysts compare these sharp drops in trade, prices and employment to what happened after WWII. Come 1946 and the world had little use for so many soldiers, machine guns and artillery shells. Millions of young men were 'de-mobed' and joined the unemployed. And smokestacks suddenly stopped smoking. But that was at the very beginning of 62-year period of credit expansion. Consumers had pent up demand for houses, cars, and other goods and services...and they had the wartime savings to buy them with. Even so, it took three years of adjustment after the war before the stock market began to turn up.

Now, we are at the other end of the cycle - the beginning of a major credit contraction, with no pent-up demand, no savings, and too much capacity to turn out too much stuff that too many people don't have the money to buy.

Meanwhile, housing prices are still going down in America...and with housing goes the lenders' collateral. U.S. residential property prices have fallen 33 months in a row. So many houses are "underwater" that the United States is beginning to look like the lost continent of Atlantis.

More foreclosures are coming. U.S. mortgage loans typically call for "down the road modifications" that lead homeowners into a kind of financial cul de sac with no way out except foreclosure. According to a study by T2 Partners, there are three more big waves of foreclosures still ahead - including those in 'prime" loans, home equity lines of credit, and in commercial real estate.

"When [these mortgage loans] start adjusting upward it will turn millions of homeowners into over-levered, underwater renters, and ensure housing is a dead asset class for years to come," says Mark Hanson of the Field Check Group.

With incomes falling and house prices weak, consumers will miss payments, default, and cut back spending. Business earnings will decline; bankruptcies will increase. This economic undertow is treacherous. Investors should stay out of the water.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• No Evidence of Recovery as Unemployment Getting Worse
• Eurozone Drops GDP Bombs
• No Way Today’s Economy is Going Back to What it Was Pre-2007
• The Fight Between Greed and Fear, Boom and Bust, Expansion and Contraction
• Water Usage by Big Companies

The Dow took a breather yesterday. The index was down 41 points.

But as far as we can tell, the rally is still underway. The G20 meeting is widely seen as a triumph. The money is flowing. People think we've seen the bottom.

"Cramer: The Depression is over," says a headline. Jim Cramer says the bottom has come and gone. That's all we need to know. If Cramer thinks the worst is over...well, it must be so.

Even Nouriel Roubini, according to Forbes, thinks there is "light at the end of the tunnel."

Japan says it's going to announce another $100 billion stimulus program this week. That should do the trick. After 17 years of bailouts and stimulus programs, the Japanese should be getting good at them. But it's a little like a guy who's getting good at suicide - if he's so good at it, you'd think he'd be dead by now.

But no...the Japanese economy is still one of the worst performers in the world; their bailouts and stimuli have done no good...maybe they've even made the situation worse.

No matter, there's a rally on...this is not the time to ask questions. Our instinct tells us this rally is going to carry the Dow back above 9,000...possibly above 10,000. Why? Because people do not go directly from believing nothing can go wrong to believing that nothing can go right. The kind of delusional optimism that took stocks up to 14,000 on the Dow...and doubled property prices...and had sober bankers buying billions' worth of ticking debt bombs doesn't disappear overnight. It has to be killed like Rasputin - many times. Stab it. Shoot it. And then douse it with gasoline and set it on fire. Maybe then, it will finally die.

That's why this rally is just a trap for the unwary...a suckers' rally. Investors are getting back on their feet just so Mr. Market can whack them again. So, if you're playing this rally...be sure to keep those stops moving up behind your stocks.

So far, this rally has recovered less than 20% of the previous losses. Typically, at least one good rally in a bear market will recover more than half of the losses. Looking at the long term, the Dow rose from the low in the early '30s of only 41 points to the high in 2007, when it was over 14,000 points. This bear market wiped out more than half of the capital gains made by investors during that whole 76-year period. A 50% bounce from the January low would put the Dow back up close to 10,000.

But we gave you our forecast yesterday. Bulls, bears, spenders, savers - our guess is that Mr. Market intends to paddle them all.

The bulls will be whacked when the Dow falls another 50% from its low - down to, say, below 4,000. The bears will be whacked when the Fed seems unable to stop deflation...and the prices in the mining and commodities sectors collapse. Then, the spenders will be trapped in a burning house of debt - with the door barred by deflation. Later, the roof will fall on the savers too - when the feds finally manage to get an inflation backfire going. The fire will get away from them immediately, we predict, burning up trillions worth of savings overnight.

But let's go back to the cheerful tidings out in the press. Sallie Mae says it is ADDING 2,000 jobs. But wait...2,000 jobs isn't really very many. And who are they employing? Debt collectors?

"Consumers fall behind on loans at record rate," says a headline in USA Today.

"A record number of consumers are falling delinquent or into default on their loans, a problem that some economists say will only get worse this year.

"A record 4.2% of consumer loans were delinquent at least 30 days in the fourth quarter, the latest data available, according to the Federal Reserve. Another 4% of consumer loans were in default, meaning they'd been written off by lenders.

"Recent data from the American Bankers Association and Moody's rating agency show the same sobering trend: More consumers are paying late - or not at all - on home, car and credit card loans.

"Job losses are closely correlated to loan defaults, economists say. And as more people become unemployed, they're increasingly giving up on loan payments."

Even sports stars are taking pay cuts. The "incredible shrinking payroll," USA Today calls it. Nearly half the baseball teams in the major leagues have cut their salary costs...by more than $10 million each. The San Diego Padres, for example, took $20 million off their payroll expense.

"The wheels have fallen off the economy," says James Chessen, chief economist for the American Bankers Association. "There have been significant job losses, and that translates into people having a hard time paying their bills."

Employers cut 663,000 jobs last month. That puts the official unemployment rate at 8.5%. It will probably be 10% by the end of the year. Since December 2007, 5.1 million people have lost their jobs, more than 2 million of them this year alone.

But "the worst is likely yet to come," continues USA Today. "Chessen expects consumer loan charge-offs and delinquencies to continue rising through the end of this year."

Move up those trailing stops, dear reader.

More news from Addison and The 5 in Baltimore:

Crude oil traded down this morning along with stocks," writes Addison in today's issue of The 5 Min. Forecast, "thus, a new trend emerges in 2009:"

"In 2008, the oil trade was all about the demise of the dollar and the threat of global energy scarcity. Whether that was a legit trade or not (we think it was and will be again soon), you can't deny crude left stocks in the dust for most of last year.

"This year oil is no longer following the '08 paradigm. Crude has become a 'reflation' trade; any time the world seems less doomed, up ticks the price of black goo...right alongside the Dow. Expect the trend to continue until further notice.

"A barrel of crude goes for $49 today."

Each weekday, the executive series e-letter The 5 Min Forecast provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less.

And more thoughts, courtesy of our new friend, Dr. Janice Dorn, describing Saturday night's tribute to Richard Russell:

"Richard did not speak for long, but when he did he talked about living through the depression and what he remembered:

"He saw Babe Ruth hit a home run.

"He watched Joe Lewis box in 1937 and 1938.

"He saw breadlines all over New York. New Fords were selling for $450 and Democrats were right outside of the Ford store handing out food.

"With a nickel, you could go from NYC to Coney Island.

"The automats were HUGE hangouts because for ten cents you could buy something to eat and sit there all day. People would buy some hot water and put ketchup in it to make tomato soup.

"He paid 75 cents to watch a very young Frank Sinatra perform with Tommy Dorsey.

"He said that, during the depression, a person could not get a job, no matter what. There were no jobs.

"Richard believes that we have not seen the bottom of this bear market. Sentiment turned bullish too quickly and appears to be [offering investors] the 'pause that refreshes to get everyone bullish again' before the downage resumes in earnest.

"The more I think about it, the more interesting it becomes that sentiment has turned bullish so quickly. When bear markets really bottom, sentiment is so negative that it really feels like the blood is not only in the streets, but that we are hemorrhaging from every orifice with nary a tourniquet in sight. That hasn't happened yet."

*** What are we doing in L.A.?

We drove up from San Diego on Sunday and are now visiting daughter Maria, who is trying to break into the motion pictures.

"Dad, it's not easy. When I first got here, it seemed like this would be so easy. Everyone was so nice and friendly. And I don't mean they aren't still nice and friendly, but the town is tougher than it looks. There must be thousands of girls just like me...working as waitresses and legal secretaries...but hoping to get into acting. I've probably had better training than most of them, but that doesn't seem to matter. I got a good agent. At least, I thought she was good. And when I get to go for a tryout I work hard to do a good job. But it doesn't seem to be working. Honestly, I don't know how people do it."

Maria seems to be doing all the right things. She is serious. She is determined. But the acting business is a hard way to earn a living. In the meantime, she has asked dad for a subsidy.

Which might raise a question; if a subsidy for GM and Wall Street is a bad idea...why is a subsidy for Maria a good idea? Glad you asked.

The way we see it, giving money to Maria is both an investment and a consumer item. We give her money because that is why we bothered to earn it in the first place - so we could help the family when they need help. It is almost a consumer item in that respect - since it gives us pleasure to be able to help her. And there are certain careers that require more investment than others. We have a son who wants to go to medical school. He is just finishing his first year of college, so we can anticipate huge investments over the next 7 years. Why not invest in Maria's career as an actress too? Maybe it will pay off; maybe it won't.

There's nothing wrong with investing in Detroit either. If anyone believes investing in Detroit is a good idea - let him go forth and good luck to him. Who knows? Maybe an investment in Detroit is a good one. Each man takes his chances and his losses.

There may also be people who want to give money to Detroit for other reasons - national pride or nostalgia, for example. If they want to do so with their own money, well again, bully for them. We wish them well.

But a government bailout is a different thing. The feds take money from people who DON'T want to invest in GM...or Citi...or AIG (if they had wanted to invest, the companies wouldn't need the government's money) and give it to the companies. By definition, unwilling investors are getting something they neither want nor deserve. And the more bailouts and stimuli the government enacts, the more they take people where they don't really want to go.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Detroit Wants Bailout
• Actor’s Life is Misery: Giving Up on London and Going to L.A.
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• World of Super Collides With World of Credit Crunch
• Something to Work With

Today, investors in financials have lost nearly everything and before this is over, I suspect the majority of banks in the West will be nationalized. This would mean a total catastrophe for those who invested in bank stocks or corporate bonds. So, no matter how strongly your private banker pushes you to load up on "cheap" financial stocks, please DO NOT go "bottom fishing" in this bankrupt industry. Banking is no longer a growth industry and financials will disappoint investors for many years. Furthermore, if you have any exposure to hedge funds, structured products, accumulators or derivatives of any kind, I sincerely urge you to get rid of all this highly toxic garbage. Such Ponzi schemes were very good for the private bankers (due to the huge amounts of commissions involved) but they are a disaster waiting to happen. Today, our planet has roughly US$600 trillion worth of derivatives and this is roughly 10 times the size of the global economy! So, please get rid of your derivatives based "investments" immediately.

Even though the financials are getting killed, our fundamentally sound stocks in solid sectors continue to report good operating results and their stock prices are much higher than the lows recorded last fall. So, this is a positive divergence and shows that the market's internal breadth is improving with fewer stocks breaking down to new lows. Another positive sign is that the Asian markets are faring much better and are nowhere near the lows recorded last fall.

During such turbulent times, it is worth remembering that your stocks represent partial ownership in underlying businesses with real assets (plants, reserves, land, machinery, technology, cash and human resources). And even though the stock market's current appraisal is not favorable, it has no connection with the intrinsic value of your holdings.

Various central banks continue to steer this economy like drunken sailors and they are injecting TRILLIONS of dollars into the system. I would argue that many nations in the West are already bankrupt (US, Britain, Germany, Spain, Iceland and Ireland come to mind) and the ONLY thing they can do now is to print even more money. For example, America's total debt is worth US$54 trillion and there is no way the US can ever hope of repaying its debt in today's money. In other words, either the US will default (highly unlikely in my view) or it will print and inflate so that this huge mountain of debt feels much smaller in the future due to the loss of its purchasing power. Remember, the best way to make debt more manageable is by inflating the supply of money in the system. And this is precisely what the various central banks are doing.

It is worth noting that nations like Germany and the United States have already started using the printing press and more nations will soon follow. When the entire planet is covered with oceans of paper "money", its purchasing power will sink and hard assets will sky-rocket. At least this is what has happened throughout history. So, please don't be fooled by this temporary contraction in hard assets and hold on to your positions. If anything, take advantage of the ongoing fire-sale and if your financial situation permits, convert more cash to quality assets in the resources sector.

A bunch of turkeys have hijacked our monetary system and all they know is how to print money. Rather than let the market clear itself out, central banks continue to use taxpayers' money to bail out insolvent institutions. This brilliant strategy has NEVER worked in the past and it will not work this time around. Instead of robbing innocent people of their savings, the establishment must allow the weak banks to go bust. For example, if Citibank is on the verge of collapse, then the US Treasury must let it go bust! All Mr. Geithner needs to do is to protect the customers of Citibank, allow Citibank's investors (shareholders and bondholders) to suffer and sell the bank's book to another institution. This is all that needs to happen. This way, depositors will not lose anything and only investors in Citibank will suffer - and they should! Why should the public share the losses with these investors? When Citibank did well in the past, did its shareholders and bondholders distribute the profits to the public? Of course not! So, why should the reverse occur now?!

Personally, I find these bailouts absurd, unethical and a total waste of valuable resources! Who gave these politicians the authority to act like investment bankers? Mr. Geithner is not a qualified 'merger & acquisition' expert, so how does he have the audacity to use other people's money to take over insolvent banks? Likewise, Mr. Bernanke is now using American taxpayers' money and buying distressed debt! I find this outrageous! Is he going to act like a debt collector when people default on their loans?

Mark my words - the establishment is only making matters worse and prolonging the pain. Moreover, by printing insane amounts of paper, the politicians are setting everyone up for an inflationary nightmare! One thing is for sure - before this drama ends, the viability of the U.S. dollar as the world's reserve currency will come under question. When the U.S. dollar starts to implode, hard assets will go through the roof. Remember, commodity prices went ballistic in the late 1930s as well as during the 1970s. We should expect similar action in the years ahead

Regards,

Puru Saxena
for The Daily Reckoning Australia

• The Glass-Steagall Act Kept Banks in Order Until 1990
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• Alan Greenspan Bears Blame for Intensity of Financial Crisis
• Federal Reserve Wants to Debase the U.S. Dollar
• Value of Derivatives Held By U.S. Commercial Banks Has Plunged By $8 trillion

Our old friend, Lord Rees-Mogg, writes in the TIMES :

"Daniel Webster's opinion should never be forgotten. Of paper money he says: 'We have suffered more from this cause than from every other cause or calamity. It has killed more men, pervaded and corrupted the choicest interests of our country more, and done more injustice than even the arms and artifices of our enemy.'

"In the 1930s some nations tried to beat the slump by competitive devaluations. In the present crisis, Britain has already experienced a very big devaluation of the pound, taking it down by a quarter against the dollar. Every country, led by the United States, has been issuing money, often in very large amounts, in order to bail out its banks. No one knows the total value of these national injections of cash into the banking systems. As the earlier injections have not restored stability to national economies, further injections inevitably will be made. All will be made in unconvertible currency, and over-issue will occur.

"Governments need to create a new world system, in which gold, as a stabiliser, should play its part. For individuals, gold remains the best insurance against future shocks and the best store of value."

Yesterday, the Dow fell another 297 points...as the market continued to react to Obama's $787 billion bailout. "Too little," say some. "Too late," say others.

But the worst may not be over for this market. Earnings are falling...for the very simple reason that people are spending less money. People spend less. Business makes less. Lower revenues; lower earnings. As we mentioned yesterday, for the first time in history, S&P stocks are losing money.

Savings rates are climbing in the United States. The trade deficit is falling. These are healthy trends for the long run. But they are hard to take in a depression.

Not only are earnings falling, P/Es are falling too. Stock prices are adjusting not only to the lower earnings, but to the new psychology of a depression era. There are times when people will pay $20 for one dollar's worth of earnings. Other times, they'll be reluctant to pay even $5. We've seen the $20 figure as recently as a couple years ago. Now, the trend is moving in the opposite direction. We're headed towards 5 bucks. That's what people will pay for $1 of earnings when this market finally reaches its bottom. Or thereabouts.

The combination of falling earnings and falling P/Es does to stock prices approximately what the Romans did to Carthage in the third Punic War. That's why we have our Crash Alert flag flying. Stock prices delenda est.

Typically, depressions come with bear markets. And bear markets come with bounces and rallies. We expected an O! Bama! bounce after the election. We got one...but much less than we expected. Stocks only rallied about 15%.

A stronger bounce will come, sooner or later. But we've put up our Crash Alert flag again - just in case. Stocks could go down another 30% - 50% first.

The news from the economy is not all bad. The shipping index has rallied - up 147% from its bottom. So, somebody must be moving something.

Beyond that, the headlines are grim. The automakers are headed down a dead end road, say the papers; they say they need $18.5 billion. Where are they going to get that kind of dough? The corporate bond market - to which corporate borrowers turn to raise money - is dead. When it comes to borrowing money, private borrowers just can't compete with the U.S. federal government. Even the states can't compete; they don't have printing presses either. California is facing a "lockdown" of public services, Bloomberg reports.

All over the world, the search for the bottom continues. Ireland seems to be edging towards default. And Japan is in a "dreadful state," says the Economist .

Things are so bad in Japan that the finance minister, Shoichi Nakagawa decided to drown his sorrows in drink. Alas, he chose the G7 meeting - at which he represented his country - to get drunk. Now, according to the New York Times , he is being forced to quit.

From what we can tell, Nakagawa is the only G7 finance minister who should stay on the job. The rest of them clearly don't know what's going on. Otherwise, they'd be drunk too.

*** Gold, as Lord Rees-Mogg notes, is the "best insurance against future shocks." A lot of people seem to think so. Gold rose $25 yesterday, to $967, and soon will be crowding $1,000 an ounce again.

Technical analysts are warning that gold is headed for a correction. "What should we do?" asks a colleague. "It looks like gold might go down in the near-term...but we don't want investors to sell out and risk being out of the market when the big move comes."

Unless you enjoy the thrills and spills of trading in and out, we don't recommend that you try to time the gold market. It's too treacherous. Yes, gold may go down in the next few months. But that has been true for the last 10 years - ever since we began recommending it. It goes up. Then, it corrects. And then, before you know it, it goes up again.

We don't think that pattern is going to change anytime soon. Gold is in a bull market that will only end when the final bubble pops - the bubble in paper money. How that will happen is anyone's guess. When it will happen is a matter of guesswork too. But the dollar delenda est too. In the meantime, we hold onto our gold and await developments.

And we suggest you do the same. Yes, the price has gone up in the past couple of days...but that doesn't mean you can't still get the yellow metal at a bargain. In fact, you can still buy an ounce of gold with the change you find under your couch cushions...no joke. Learn all about penny-per-ounce gold here .

*** Here's an interesting little item: "US Military Will Offer Path to Citizenship," says the New York Times . Why not? It worked for the Romans - for a while. Then, when the barbarians in the ranks became numerous and powerful, they took over.

Richard Florida, writing in The Atlantic :

"'One thing seems probable to me,' said Peer Steinbrück, the German finance minister, in September 2008. As a result of the crisis, 'the United States will lose its status as the superpower of the global financial system.' You don't have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire - the fall long prophesied by Paul Kennedy and others.

"Big international economic crises - the crash of 1873, the Great Depression - have a way of upending the geopolitical order, and hastening the fall of old powers and the rise of new ones. In The Post-American World (published some months before the Wall Street meltdown), Fareed Zakaria argued that modern history's third great power shift was already upon us - the rise of the West in the 15th century and the rise of America in the 19th century being the two previous sea changes.

"But Zakaria added that this transition is defined less by American decline than by 'the rise of the rest.' We're to look forward to a world economy, he wrote, 'defined and directed from many places and by many peoples.' That's surely true. Yet the course of events since Steinbrück's remarks should give pause to those who believe the mantle of global leadership will soon be passed. The crisis has exposed deep structural problems, not just in the U.S. but worldwide. Europe's model of banking has proved no more resilient than America's, and China has shown that it remains every bit the codependent partner of the United States. The Dow, down more than a third last year, was actually among the world's better-performing stock-market indices. Foreign capital has flooded into the U.S., which apparently remains a safe haven, at least for now, in uncertain times."

We remember our Five Big E's from a couple of years ago.

They were the underlying trends that we thought were unstoppable. Let's see...

1. Our Experimental money system - with faith-based paper dollars at the foundation - was doomed
2. The U.S. Empire was peaking out
3. Energy was becoming more expensive
4. Wealth and power were moving to the East.
5. And the Economy was headed for a crisis.

The only one of those that looks like a bad bet is number 3. Energy is a lot cheaper now that it was a year ago. But does that mean that the trend towards more expensive energy is over? Maybe...maybe not.

The price of crude oil dropped below $35 this week. Yesterday, it traded at about $37.
"I think we've seen the bottom," says colleague Simone Wapler.

Simone explains that many of the projects that were supposed to bring more oil on line have been abandoned. That will mean shorter supplies than forecast. Economic growth forecasts have been cut too...which will cut consumption. But inevitably, Asian economies will grow...and they will use more energy. There are 700 cars per 1,000 people in the US, she points out. In China, the figure is barely 20. One way or another, Asia is probably going to use more energy in the future...which is probably going to increase the price of oil.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

P.S. Colleague Byron King warns that although it's easy to be lulled into believing that low energy prices are here to stay, he wouldn't get too used to the idea. In fact, Byron thinks we are heading into what could easily be the most vicious and unpredictable financial cycle of the past 150 years. Learn how to prepare yourself (and even profit) from the 'forever oil crash' by clicking here .

• All the World’s Stock Exchanges are Now Officially in Bear Markets
• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Your Second Chance to Escape the Bear Market
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• Come And Get It!

So sales of new homes in America are down 38% year-over-year and prices are at their lowest level in the last five years. The gains of the housing boom are melting away. But does it have anything to with Australia? Or are we just trying to whip you into a frenzy of despair and doom on a Friday afternoon?

Well, no. We're not trying to do that. But we are trying to suggest that the collapse of housing booms in the U.S. and the U.K. IS something that could happen here in Australia, too. It is possible. And if it's possible, it's wise to work out how it might happen and what, if anything, you can do to prepare for it.

But if the whole concept of a house price crash leading to more trouble in an economy offends you in some way, it's probably best not to read the Daily Reckoning.

Before we move on, a quick note about Jim Davidson's new letter we told you about yesterday. The odds are that the letter does indeed cater to North American investors. We're investigating and will report back. We would say that Jim's insight is worth reading even if the investment advice is not practical for Australian investors. But please note we are not far away from our own "big picture" product that DOES speak to the needs of Australian investors specifically. Stay tuned!

Now, what about stocks? The S&P 500 reversed four strong days of gains to give up 3.3%. The bad housing data and a weak durable goods orders report didn't add much to Wall Street's mood. There's one line of emotional exuberance (not thought) that revels in the idea that an $850 billion government stimulus will lead to an earnings recovery for S&P 500 firms. And then there is reality.

Australian reality is that the Reserve Bank will probably serve up another 100 basis point interest rate cut next week. You'll probably see another "stimulus" plan from the government, too. How exactly more credit and a cash binge will support asset values escapes us.

But it's possible that Australia is now in lock-step with every other central bank and government in the world, and that all monetary roads lead to Zimbabwe, where a brave but brittle paper currency has gone to its god like a soldier, to paraphrase Rudyard Kipling.

Rest in peace, Zimbabwe dollar. Robert Mugabe and Gideon Gono have blown out your brains and gutted the Zimbabwe economy. Yes, the Zim dollar has gone to that great paper currency shredder in the sky overnight. 'Twas ever thus with fiat money. Just yesterday we were discussing the fate of the Zim dollar with Swarm Trader Gabriel Andre.

This was after the lights went out in Melbourne around 3pm under stifling 40 degree heat. Your entire crew at the Old Hat Factory quickly decamped down the street to Cafe Presse, to liberate the beer at that fine establishment before it was fatally compromised by the heat.

Up on the wall behind the bar at the Cafe and in amongst the bottles of wine (the Krinklewood Francesca Rose from Broke in the Lower Hunter Valley being our favourite in these torrid conditions) are samples of paper money from all over the world, some already dead, others still dying. And right smack in the middle was a billion dollar note from Zimbabwe.

That's billion with a "b". And before yesterday, you couldn't even buy a beer with it. That's beer with a "b".

As of last night, that currency is now worth what everyone suspected: nothing. The Zimbabwean monetary authorities said last rites over the scrap of paper and declared a trinity of currencies-the U.S. dollar, the British pound, and the Botswana pula-as legal tender.

Beware!

Competitive currency valuation is a dangerous game. To be fair, Zimbabwe didn't engage in what you'd call a normal competitive currency devaluation. It simply printed so much money so quickly that prices ceased to have anything to do with reality.

That is one reason why values-all sorts of values, mind you-become so distorted during inflation. Social cohesion is strained and economic activity disintegrates as people have no reliable medium of exchange. If you can't trade, you barter, beg, bargain, or steal. Unless you're the government, in which case theft is legal (either through taxation or inflation).

In the global competitive currency devaluation sweepstakes, the United States seems to be winning at the moment, if you can call it winning. By "winning" we mean that the U.S. central bank cut its interest rates the fastest and the furthest before other central banks followed. This rate-slashing effort, along with all the fiscal measures since (TARP, US$850bn stimulus) are designed to combat the credit depression, the housing crash, and lately, rising unemployment.

Normally, a country deliberately sells its own currency (or holds down its rate of appreciation against the currencies of its trading partners) in an effort to boost local exports. In fact, competitive currency devaluation has been the exact strategy of Asian exporters to the U.S. for, well, for the last thirty years. Keep your currency weak against the greenback and your goods are cheaper in the world's largest export market.

This vaguely mercantilist system all operated on the premise that the U.S. consumer could afford all the production of the world's factories. And he could! At least for awhile, and with the help of consumer credit, or lines of credit based on asset values (stocks and houses).

But now, that whole relationship (we think, they sweat), is broken because the credit has been cut off. Yet the rest of the world is now following U.S. monetary policy down the path of devaluation. It is exactly this simultaneous global paper currency devaluation we advised people to prepare for in the last issue of Diggers and Drillers (How to Prepare for the Coming Devaluation). And now it's here!

So how is the U.S. winning this race? Well, now that the rest of the world is slashing interest rates to zero and marching down the paper path, the U.S. dollar looks relatively more attractive. The U.S. has already taken a lot of currency debasing steps. It has a sort of first-mover advantage in destroying the purchasing power of its currency for its citizens. Expect the dollar to strengthen against other paper money, but to weaken against tangible goods like gold and oil.

And if you're worried that the U.S. has finished debasing itself, don't!

There will be more debasement to come. The U.S. has not yet begun to defile itself! The Fed is now prepared to print money to buy U.S. Treasury bonds in an attempt to bring long-term interest rates down and get the credit market going again. Yes dear reader, there is some major defilement ahead.

This raises a disturbing prospect. But since we walked down this line of inquiry, we may as well follow it to its logical conclusion: the insolvency in the financial system is a preview of the insolvency that could hit many households in America, the U.K. and Australia.

As our friend John Robb puts, it, "Here in the West, the crisis we are seeing might have started in the shadow banking sector with the collapse of subprime mortgages. However, the unexpected happened: it revealed the US/Euro middle class as insolvent and forced a shift in behaviour (towards something new). That insolvency and shift in behaviour will sink chances of economic recovery from gov't stimulus (you don't add debt in a debt driven crisis) and financial sector bailouts."

Next week, we promise to tell you more about the "something new." And it will not be nearly as gloomy. In fact, it's quite exciting.

In the meantime, the public erroneously believes that bailouts and stimuli will cure the ills of a mutli-decade addiction to credit and living beyond one's means, both personally and as a nation. Maybe that's why stock prices were up this week, as the Obama plan moved through Congress. But did you notice that gold is back up over $900?

But wait! Before we drone on about gold, a reader doth protest! Appropriating our royal we, he writes:

"We at DR are really really smart and we think gold is just great, it is really really nice stuff. In fact if we were in charge we would not go for these stimulus packages, they just stuff up the free market. Instead we would put all that money into gold, we really love it. Gold Gold Gold, we do not have gold fever, just think of what you could do with the stuff, you could buy it and hold it and lust over it and hope it goes up. Yippy. We even found someone who reckons the Bundesbank would be mad to sell it at today's prices, they should just hold it like we would, remember all those things you can do with it. It is really really nice stuff, it should go to at least 2,500, if you love it as much as we do, you would pay anything for it. It's not good fever, it is solid investment advice. We can think of just so many reasons why gold should go up, it is such remarkable stuff, I bet if I left it under my bed while I had a wet dream about it, it would just elevate all by itself. Those bloody Germans must be nuts to sell something like that."

Phillip D.

What's that? Sorry! We couldn't hear you. We had two big gold nuggets stuffed in our ears, while dining on a breakfast of gold flakes, and downing a tall glass of liquid gold. An outstanding start to the day, but a bit rich.

Yes, it's true. You can't eat gold. You might also have trouble buying a latte with it. But you shouldn't be concerned so much with gold becoming the next everyday medium of exchange in the real world. Instead, you should wonder how to preserve your net worth from falling share prices and falling house prices.

But hey, if we have gold fever, we've got plenty of company. "Combined with an aggressive fiscal policy, it is clear that the authorities are going 'all-in' to try to mitigate the near-term effects of the economic collapse," says David Einhorn, head of the Greenlight Capital hedge fund. "Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way. Deflation will lead to further steps to debase the currency, while inflation speaks for itself."

The illustrious Adrian Ash at Bullionvault.com has more in a recent article quoting other voices on the Street and in the City. "I think gold is rising because of fiscal deterioration and the prospect that the US [Treasury's debt] may be downgraded," says Tom Sowanick at the $22 billion Clearbrook Financial funds in Princeton, New Jersey.

"They are printing trillions of dollars worth of currencies," agrees Robert Lutts of the $400 million Cabot Money funds in Massachusetts, also speaking to Bloomberg, "and there is no real asset behind it. So every single Dollar in my pocket is going to be worth less and less every day."

Where is it all leading? Probably to a gold bubble. "Inevitably, low interest rates lead to a gold bubble," says David North, head of asset allocation at the UK's No.1 institutional investor, Legal & General. But as all five year old children ask on the way to Grandma's, are we there yet?

Not likely. But that's your risk as a precious metals investor. Gold doesn't pay a dividend. It costs you to store it. And it can't increase its earnings. All it can do is sit there, intrinsically worth nothing, but traditionally a store of value and wealth as monetary authorities resort to trickery and fraud in their attempts to dupe the people and preserve power. But hey, if you trust these guys, don't go for the gold!

More reader mail. Is your editor a hypocrite? Or just an inconsistent imbecile who likes to refer to himself in the third person? One reader takes issue with our taking issue with Sheila Bair's scheme to blow public money on bad bank assets.

"I love your statement "How can the "fair value" price be rational while the market price is not?"

The delicious irony of this is that very nature of your business is to then tell your subscribers that the market price of this security that we're tipping you should buy or sell is not rational....the market has it all wrong and we know so. So on the one hand its suites you to assume the market price is efficient but on the other.....Mmmm

I also love the idea that someone can just join the dots to arrive at a conclusion i.e. this happened because of this and therefore if this happens and this happens and add in a dab of this all of sudden this will happen.....AND you can make money from it.

But then i spose the very nature of you business is to create what seems like a logical narrative about the future that people will associate with when logically you, me, or anyone else for the matter, have no idea about what the future holds.....never ends to amuse me!!

Regards

David

Well played Sir. We are happy to amuse you. But you are not quite right!

Why are market prices for toxic assets "rational" when stock prices for certain securities are not? There is a great debate to be had between "mark-to-model" accounting and "fair value" accounting. We will not have it here today, though.

But you can make a perfectly logical distinction between mispriced stocks and misprices mortgage-backed securities and collateralised debt obligations. What you're willing to pay for a stock depends on what you think of its future earnings prospects. While not entirely subjective, this is what accounts for the difference between buyers and sellers. They both reach different conclusions about the present value of the future earnings of a given business.

Maybe have the same knowledge about the business, the management, and its earnings history. Maybe they don't. They are both equally unaware of what the future holds. The fact that they reach different conclusions about what the future holds is what makes a market. One of them will be right. The other will not. But in both cases, it comes down to how accurate their assessment of the earnings power of the business is and whether the current price puts those earnings at a premium or a discount.

Investors in individual securities CAN have an advantage over other investors. Sometimes this advantage is informational and specialist (i.e. they know more about an industry like pharma and what drug will work). Other times, it just comes down to good old fashioned security analysis, where you can spot a dollar's worth of earnings on sale for fifty cents, or you find a company selling for something close to net tangible assets (Buffett and Graham). But the market misprices stocks all the time based on incomplete knowledge and inexact forecasts of what the future holds.

You're right that we have no idea what the future holds. Nobody does, or can! But you can read what we think will happen every day right here in this space. Maybe we're right. Maybe we're wrong. Either way, the share tips we make in our paid publications are based on a world-view, security analysis, and reflect our synthesis of the two. At least it's transparent. And if you don't like it, you don't have to buy it!

Securities backed by housing values don't have any earnings variability. They don't have any earnings at all, in fact. They derive their value based on house prices, and house prices are falling as foreclosures rise and the credit bubble deflates. Bair wants to pay "fair value" for the securities because her real goal is to transfer taxpayer money to bank balance sheets to shore up capital while excising the non-performing, decomposing mortgage assets to the public sector.

We are against this on principle.

But if you want to use logic, we'd say her method of price discovery is "inductive." She begins with a particular goal (recapitalise banks and quarantine the sludge at a "bad bank") and arrives at a general conclusion: we must pay fair value!

Our approach to investment is deductive: begin with general observations to arrive at a particular conclusion i.e. look for businesses that increase earnings quickly, have solid balance sheets, and where you can measure management's historic performance with shareholder capital, or, in the case of small cap companies, you position yourself to profit from rapid earnings growth that may happen (your risk is that it doesn't.)

In any case, we'd say the main difference is that Bair's estimate of "fair value" isn't strictly wrong because it's at odds with the market price. It's wrong because she's not buying the assets as an investor. She's buying them as a regulator and policy maker, and she's using other people's money. Her motivation it's rational or logical, it's political. That alone should make you suspicious, if not deeply sceptical.

That's it for the week. Thanks for bearing with us. There are some questions about the sustainability of global growth that we never got to in this space. But the answers to those questions-at least our attempt at answers-belong in the category of "things that suggest there is a lot of money to be made in the next ten years." More on them next week. Until then!

Dan Denning
for The Daily Reckoning Australia

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Yes, dear reader... we're breaking out... We're not going to let these prison bars stop us. A whole generation of American investors is being fattened for slaughter... we're not going to be among them.

Let's look at yesterday's headlines just to see what is going on.

The Dow rose 62 points yesterday. Oil held steady at $48. Gold went up $8. Yields are rising... but you still get paid nothing when you lend money to the U.S. government.

The economic news tells us that things are getting worse. Alcoa said it will lay off 13,500 workers. But all across the country, businesses are either laying off old workers or not hiring new ones. Most of the joblessness never makes the news - until it is already painful to the fellows without jobs. Small businesses don't announce layoffs. Nor do they send out a press release when they decide not to hire a new kid at the carwash.

After the worst car sales in half a century, Toyota says it is shutting down its plant for 11 days.

And a figure out yesterday tells us that consumer bankruptcies rose 33% last year. But the crash came late in 2008; job cuts didn't really begin until the last quarter. People didn't have a chance to get their paperwork together. This year, the bankruptcy numbers should really soar.

Most likely, Americans are still in the dark about what is going on. Heck... their leaders are driving without headlights... why shouldn't the lumpen too? People don't seem too sore about what happened to them in '08. They're still hopeful that a new administration will find a way to fix things. Yes, they're planning on cutting back spending and saving money... but they have no idea how their attempts at thrift - magnified by millions of other citizens - will affect the economy.

Levy Forecasts, which was generally right about the financial crash, now says the "damage to the economy will rapidly accelerate the financial crisis." In other words, the financial crash is causing an economic crash... which will cause a worse financial crash.

Profits are made at the margin. Most sales merely cover costs. It's the marginal extra buyer - preferably the one who spends his savings, rather his salary - that provides business with profits. On a macro level, salaries are a cost to business. When a man spends his salary, business is merely getting back the money it paid out in labor costs. But when a man spends savings, the money falls to the bottom line as profit.

Who is going to spend savings in '09? Who is going to spend at all? That's why business profits are going to fall harder than most people suspect. Unemployment is going up more than most people expect. And stocks are going down more than most people expect.

Barron's survey of Wall Street's "top strategists" tells us that the consensus among these fellows is that stock prices will go up 18% in 2009. But these are the same strategists who thought stock prices were going up in 2008 too - instead of crashing 35% - 40%.

Here at The Daily Reckoning, we're with the Levy bros. Our guess is that stocks will rally... and then crash again, ending the year below where they began it.

There is no doubt that the U.S. economy has entered a major downturn... probably a generational slump, in which the errors of an entire generation will be corrected.

What do we mean by that? Well, since the early days of the first Reagan Administration Americans have been building fences, to keep themselves confined, and forging chains, to wrap around their own ankles. They built cars and houses that demanded more energy - when energy was becoming more expensive. They became accustomed to lifestyles that cost about 10% more than they earned. They began to think that houses and stocks would go up every year... and that foreigners would lend them money forever. Well... you know what happened. Every link was heated white hot in the furnace of mass delusion and hammered on the anvil of wishful thinking - while public officials urged them on!

Now, the whole country drags around these heavy chains of debt... private debt in all its forms - mortgages, student loans, credit cards, home equity lines, commercial loans, private equity finance, bridge loans, road loans, ditch loans. Last year, all of a sudden, this debt got so heavy, the poor debtors started to pitch over. Lenders looked around and worried, not about the return on their money, but the return OF their money. In many cases, it didn't look like they'd get it back. That is what caused the 'credit crisis' - lenders closed their wallets to all borrowers - save one, the only borrower who was 100% sure to pay you back the money when you needed it, the U.S. government. As a result, bonds and gold were the only two major asset classes to go up last year. People bought government bonds to protect against the implosion of private debt. And they bought gold to protect against government bonds.

We recall Nassim Taleb's turkeys. Until Thanksgiving, he says, the turkey lives well. Everyday, the food arrives. Everyday, he gets bigger and fatter. Then, one day, just before the third Thursday in November, when Americans celebrate their traditional Thanksgiving dinner... with no warning, comes the knife... the crash... the collapse... the discontinuity... the 7 sigma event in the turkey's life that changes everything.

"That's why we need to study history," says Elizabeth, who is working on a master's degree in 18th century French history at the Sorbonne. "If the turkeys had studied history, they might been warned. In early November, they might have started whispering to each other in the yard: 'it's a set-up... we're all going to be sent to the ovens... break-out planned for tomorrow at dinner... pass it on.' Then, while a few birds got into a squawk to provide a diversion, the others might have rushed the gate. Instead, they didn't know what was coming and took it in the neck."

There are plenty of histories of finance - oral and written. But investors pay no attention. One generation of turkeys learns. The next forgets. One makes money; the next loses it. Every generation has to get its own neck chopped in its own way.

*** With so many citizens groaning and collapsing under the weight of so much debt, it is entirely foreseeable that the feds should pretend to come to their aid. Today's news tells us that Barack Obama's rescue mission will bring about $770 billion of cash with it. This comes on top of other rescue missions mounted by the Bush Administration and the Federal Reserve. Altogether, the total cost of these mercy efforts is into the trillions.

In fact, this morning, the Congressional Budget Office has reported that the U.S. government will run a budget deficit of $1.2 trillion in 2009... and that's not taking into account the stimulus programs.

We have explained why bailouts don't work. You can't solve a problem caused by too much debt by adding more debt. The 'hair of the dog' technique won't work - not even if you throw in the whole pooch. But it will have an effect - it will increase the weight of debt to the whole society. The forges are hot again... the hammers are clanging... the smithies are sweaty; now they're building new chains of debt - public debt. They're putting up a chain-link fence around the entire United States... and shackling every citizen to a monumental ball. Next year alone, the U.S. federal deficit will go to $1.5 trillion to $2 trillion - or about $20,000 for every family in the country. Over the course of the slump, the total could run to $100,000 per family. This extra public debt is the only sure outcome of the bailout projects.

How will Americans possibly carry so much public debt - along with their already bone-crushing private debt - without collapsing? Who would lend these sub-prime borrowers so much money in the first place?

Give us 24 hours and we'll have answers to those questions... and give you our break-out plan too. The rest of the turkeys may get the axe... but we're headed over the fence. We've got wings, remember... .

*** A dear reader writes: "I respectfully disagree with your assumption regarding the 'bounce.' One of the goals of the Bush Administration is to have significant government 'equity' presence in Wall Street. This is called 'Privatization' when it applies to Social Security - but whatever the Government 'privatizes' but retains a hand in, it really 'socializes.'

"Sufficient 'equity' has been poured into NYSE stocks, that the Government can manipulate the Dow (DJIA) much more than it could five years ago.

"As most people find the DJIA and the American economy synonymous, a slow and gentle rise in the Dow is cheering to many. So it is done.

"The Hunts attempted the same thing, with vastly different purpose, with the silver market some 30 years ago. They tried to corner it - and lost. The price went up - but they couldn't get enough of a controlling share to 'own' the market, so they were left with vast holdings of massively overpriced silver.

"(I suspect that the fluctuations in oil prices may have been something similar, just from the pattern - but that's sheer speculation.)

"We (the taxpayer) are gathering a massive market portfolio of overpriced equities. Like dime stocks, we can drive the price up; but it is so volatile, we cannot sell it all at the higher price - and that would crash the market soundly.

"Our acceleration into Market Socialism is another version of what Governments habitually do - play shell games with values, in order to reap profits. I'm sure that the Soviet Union allowed a little stock market to run here or there, eh? The NYSE is Uncle's pet now, and it is on strings. Never mind that it is dead. It can still dance."

*** England isn't so merry these days. First, it is cold - temperatures fell to minus 10 centigrade, according to that reliable source of meteorological intelligence - the Sun. We knew it was cold because the Sun girl on page 3 had goose bumps all over her naked body. But at least she wasn't sick with the flu. A record 2.4 million workers called in sick yesterday in England - one out of 12 staff was out. Another two million stayed at home because they don't have jobs to go to. The financial storm that hit Britain last year continues to send waves over the island's gunwhales. Big retailer Marks & Spencer said it is cutting 1,700 jobs today. And the firm founded by Josiah Wedgewood 250 years ago went bust. UK stocks are down about 40%. Houses are going down fast too. Unemployment is going up. And Britain's most profitable industry - finance has gone into a slump. Apparently, half the country is either out of work, down with the flu, recovering from the flu, or pretending to have it so they don't have to go to work.

• Investors Are Betting On Recovery
• The French are Feeling Pretty Smug
• Right and Left Side of Politics are Corrupted
• Are Stock Market Investors Really Such Optimists?
• The Collapse of Gold and Commodities