Of course it was misery for many of the test subjects. People were so eager to get out of the East German control group, they risked their lives jumping over the barbed wire. Then, when the wall was down, the population of East Germany collapsed...more than one out of every ten people moved to the West!

But it was a great experiment for economists. Too bad they didn't learn anything.

What they should have learned is that when it comes to making people materially better off, government spending is a poor way to do it. It's great for the few favored firms who help Washington raise and spend its trillions. It's great for Goldman, in other words.

But what if you don't have an inside track with the government? Well, you're out of luck. You get to stand in line to buy inferior goods and services - produced by government-owned industries and protected monopolies. That was what the East Germans did. And, of course, you get government bureaucrats telling you what to do...and preventing you from improving the quality of your life.

That's what they did in East Germany. And that's what they're doing, now, in the United States of America - in a less obvious, less heavy- handed fashion. Who owns the biggest auto company in the US? Who provides the finance for the finance industry? Who controls the health care and education industries? Who's the biggest employer? Who finances our houses? Who runs our banks?

Well...you know the answer.

But here's another question: who's headed for bankruptcy? Same answer.

What can you do about it? All you can do is to anticipate where this is heading...and position yourself to profit. Or, at least position yourself to protect your assets.

In that regard, you may want to replace the FED with the GLD, if you know what we mean. The Fed is derelict in its duty to protect your paper dollars. GLD - an ETF for gold - is a very simple way of doing your own central banking.

But should you buy GLD now? Ah...they don't make it easy, do they?

So, should you buy gold now?

A quick answer: it depends.

If you're buying gold for quick profits, you will probably be disappointed if you buy it now. The price has been going up for weeks. It's probably ready for a rest.

Also, gold moves up with stock prices - both anticipating an inflationary recovery. We think this will turn out to be a mistake. There is no real recovery underway. And no inflation either.

If and when stocks collapse, gold will go down too. At least for a while.

But if you are buying gold as the Chinese and the Indians are buying it - as a monetary reserve, not a speculation - there is no time like the present. Sometime in the future, we wish we could tell you when, gold at $1,100 will seem like a giveaway.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Gorbachev and the Most Complete Test in Economic History
• Gold is in a Bull Market
• The Codependent Relationship Between China and the United States
• U.S. Government Takes Over the Economy
• Housing and Unemployment Are Weaknesses in the U.S. Economy

All thirty components of the Dow Jones Industrials fell in New York trading on Thursday. In total, the index fell over 200 points and 2.09%. The slap in the face came from a survey of manufacturing activity that indicated a slow-down in the rate of expansion.

If you're an optimist, the good news is that manufacturing activity - as measured by the survey - is still expanding. But investors looked at the report and must have begun thinking that the euphoria of the last six months is premature. "Maybe," they are thinking, "the rally in the stock market is completely divorced from the reality in the real economy where real things are made."

Today we promised to talk about world class speculations as the antidote to Ponzi finance. Mind you these are still speculations. And we'll get to that in just one second. It's none too soon, given the slow-motion meltdown of America's regional banks and the bankruptcy of the agency charged with insuring them (the FDIC).

But first, just a reminder about the gold conference in Canberra November 2nd through 5th in Canberra. You can read about it here. Space is limited, so if you're keen to go, you'd better move fast. Your editor will be there too, for the first time, and is looking forward to a world-class line up of speakers on gold as money and gold investments.

And that brings us to another point. On Tuesday we had the pleasure of sitting down for coffee at The Pelican here in St. Kilda with Dr. Steve Kates and his wife. Among other things, we discussed that monetary parable that is now 70-years old, the Wizard of Oz. Not many people know that the story was about whether the U.S. would have a gold standard or a gold and silver standard (bi-metal). Or neither!

Dr. Kates is a senior lecturer on economics and finance at RMIT here in Melbourne. We were introduced to each other by a mutual friend, and are glad to have met him. So glad, in fact, that today's guest essay is from Dr. Kates. He recently gave testimony to a Senate panel about why the stimulus is such a bad idea. Have a look below. You'll be hearing more from him in this space, hopefully.

"Part of the problem with the current thinking," he said on Tuesday, "is that when you're born into it, all the assumptions and premises of the system are not things you'd actually question. It's only when the system starts breaking down that people are forced to stop and ask what's wrong. All of today's policy makers and economists are born and raised in Keynesianism, and that's why there are so few people who can step outside of it to see its failures."

For once in his life your editor managed to shut up and let someone else continue talking. It was a great conversation, and as we said, we hope to bring you more like it in the future. One subject sure to come up is the financialisation of the economy and what economist Hyman Minsky called the era of Ponzi Finance.

A brief explanation. Minsky showed that the longer credit-financed expansions went on, the more all economic activity became "financialised." That is, debt growth leads to excessive leverage in household, corporate, and public balance sheets. This makes the entire economy (as we're now seeing) much more sensitive to changes in interest rates (the cost of capital) and changes in asset prices (which exist at large multiples to tangible equity on the balance sheet).

In the early stages of debt growth, the economy endures Hedge Finance, where cash flows are sufficient to make both principal and interest payments on debt. In the next stage, Speculative Finance, cash flows cover interest expense but not the principal. These leads to more borrowing for the purchases of financial assets to grow the balance sheet.

When you reach the Ponzi Finance stage, business cash flows are not sufficient to pay either interest or principal payments. New debt must be taken on or assets sold to keep the enterprise as a going concern. But by now, the real purpose of the business - providing goods and services that consumers want at a competitive price - has been entirely supplanted by the need to service and roll over debt.

That's where we are now, globally speaking. And it's not a good place to be. In the States, for example, the FDIC is trying to prevent the collapse of the Ponzi Finance economy by a drip-feed of regional bank failures. These banks are generally not as leveraged as the money-centre banks in New York. But they are apparently small enough to fail, as long as they don't fail all at once. And they are not well connected politically, lacking the cover give to Wall Street by Washington.

What's killing the banks is the inability to roll over new debt, even as assets on the balance sheet shed value. This is the ongoing deterioration in bank collateral we've written about before, and it's largely driven by a 10-year binge of speculation in residential real estate (sound familiar). That binge is still purging.

The FDIC - the American regulator charged with insuring depositors - is going bankrupt (if, in fact, it is not broke already). It will be funded by new money printed by the Fed. The Fed is allowing the drip-feed of failures (managing it, even) because it prevents a landslide of bank failures, which might touch off another crisis of confidence e in the banking sector (and more bank runs).

What's more, the Fed fears that an en masse collapse of U.S. banks will lead to a repeat of the Depression era contraction in money supply. When banks failed in the 1930s, the money supply contracted and deflation set in. Ben Bernanke, ever the historian of the Depression, must reckon that a slow-motion banking collapse allows the Fed to keep the money supply from collapsing by extending huge credit to the money centre banks, which are largely nationalising the distribution of mortgage and personal credit.

But what is the fallout from this? If the Fed triages the banking system by pumping more bogus cash into the FDIC, surely that would be a death-by-a-thousand-cuts for the U.S. dollar, wouldn't it? But then this strategy is nothing new. The Fed has been destroying the purchasing power of the dollar in that way since 1913. An inflation rate of 3-4% a year disguises the systematic theft of purchasing power that's inherent to fiat money.

Today, the Fed hopes to prevent a large collapse in the money supply (bank's create more money than the Fed through fractional reserve banking) by incrementally distributing bank failures across the calendar. So far, it's working...or...the bit-by-bit failure strategy is not alarming people about the systemic failure of the Ponzi Finance economy.

But it is failing. So what can you do? Well, as often as we've written about gold, today we will make a distinction between bullion and stocks. Bullion, physical gold you own and store, provides you with a tangible hedge to cash. It should be part of your Ponzi mitigation strategy.

Gold stocks have a role too, though. They give you leverage to the gold price. And the gold price should continue going up as the dollar accelerates its terminal decline. But there are a couple of things you should know about gold stocks and gold mining.

First, gold mining is a terrible business. Your capital costs are large and upfront. The asset is an inherently depleting asset (the mine has a life and production of the resource depletes the resource). This is arguably better than holding billions of housing-backed securities, which don't so much deplete as they disintegrate.

But valuing gold stocks - especially the explorers - is not something Graham and Dodd would have much luck with. Most of the companies don't have regular earnings. And you have to deal with fluctuating underlying commodity prices. Plus, the companies have to get lucky and find gold in economically mineable deposits for which they've received the proper permits and government and environmental approvals.

Altogether it's a terrible investment, but an excellent speculation. As long as you're aware of the difference, the benefits become obvious. The tiny gold stocks can go up ten and twenty times on moves in the gold price and upon successful exploration. That's as good as you're going to get when it comes to big profits from the decline of the dollar.

But as a speculative position, don't go overboard. Diversify with a handful of gold speculations and make sure it's with speculative money. Diggers and Drillers analyst Dr. Alex Cowie is currently looking into the gold junior universe and will report back shortly on his findings. Until then...

Dan Denning
for The Daily Reckoning Australia

• The FDIC Is in Trouble
• Gold Coins for $870-$890 An Ounce
• Chartwell Enterprises – Pyramid or Ponzi?
• One in Four US banks Announce Unprofitable Quarter
• Fannie and Freddie are Finito

Yesterday, gold took a big dip down - minus $15. It closed under the $1,000 level. Now we'll find out if the Chinese are supporting it at $1,000...or not.

If so, it should soon bounce back. If not...well, who knows?

But our Trade of the Decade doesn't worry about what the metal does on a day-to-day basis. Back in 1998, we just noticed that the gold/stocks relationship had reached an absurd extreme. It took 43 ounces of gold to buy the Dow stocks. We figured that ratio was bound to come down.

It has. At today's prices, you can buy the Dow for less than 10 ounces of gold.

David Rosenberg looks at 10-year returns by asset class. Here's his chart:

Buy gold on dips; sell stocks on rallies. It was good advice 10 years ago. Is it still good advice?

Of course, it depends on what happens next. If the feds succeed at inspiring growth without also causing higher levels of inflation, gold will be a bad place for your money - relative to stocks. But here at The Daily Reckoning we are cheerfully, confidently, and calmly enjoying a depression. We don't think it will stop any time soon.

What that means to us is that stocks are not likely to go up. And we don't expect inflation to increase anytime soon either. So, as to gold itself, that puts us in an ambiguous position. On the one hand, depression will probably not push up gold prices - at least, not at the beginning. On the other hand, it won't push up stock prices either.

On the one hand, the economy is probably going to sink further. Yesterday's news brought the rally in stocks to a halt. The Dow lost 41 points after it was reported that the rate of existing house sales had fallen in August, following 4 months of gains.

But it's very hard to make a diagnosis on this patient. He's so doped up.

The Fed pumped $2 trillion worth of drugs into the economy. It won't say exactly what elixirs it used...or what veins it put them into. But all this money must have an effect. Federal employment, for example, is rising.

Here, an aside. When people get government jobs, the employment numbers increase. But is the economy better off? It depends on what the people are doing, doesn't it. If you think additional federal workers add to our prosperity or the quality of our lives...well, you probably shouldn't be reading The Daily Reckoning. In our view, the feds already had too many parasites on the payroll.

But if the feds can make the world a better place, let's hire more of them! Heck, let's all work for the federal government.

Even with rising federal employment, the economy is still sinking. One headline tells us that luxury hotels may be headed for bankruptcy; their $850 rooms are empty. Another tells us that there are people living in the drainpipes under Las Vegas. Obvious solution: give the drainpipe people jobs with the government...and put them up in the luxury rooms! Hey...they can call room service and stimulate the economy even further.

The US Post Office has a problem too. It may need a $4 billion bailout, says one news item. Another tells us that 'exhaustion' has hit a new record. 'Exhaustion' refers to people whose unemployment benefits have run out. Apparently, more than half the unemployed run out of benefits before they find a new job - more than ever before.

Which brings us to the other hand. Without a real recovery in the real economy, the feds are going to keep their hands on the pumps. While the depression decreases the odds of inflation...the feds' reaction increases them.

Of course, gold doesn't always need inflation to rise...and stocks can do what they want.

So let's see...economy sinking...should be bad for inflation. But maybe not...

Or, economy sinks with falling prices...should be bad for gold. But maybe not...

Or, economy improves...should be good for gold. But maybe not...

On the one hand...on the other hand... Harry Truman once remarked, "Send me a one-armed economist." We're tempted to cut off one of the hands ourselves.

But let's forget the hands. Major trends tend to run in long, long cycles. Consumer credit has been expanding since 1945. It is contracting now. That trend is not likely to end after just six quarters. Instead, it is likely to continue for a long time. And it is likely to inspire tremendous exertions to stop it on the part of the feds. As to the exact type of 'flation that will result, we can only guess that there will be more of it. As to stocks, we guess that they will decline - in real terms - as long as the credit contraction continues. And as to gold, it is sure to go up and down.

At $1,000, is gold cheap?

The first car we ever owned was a '37 Buick that we bought in the '60s for just $75. It ran well. The only problem it had was a dented trunk door. New, that car cost just $825 - or about 24 ounces of gold.

Today, 24 ounces of gold is worth about $24,000. Can you buy a new car for that? Well...yes, you can. But not a new Buick. The 2009 Buick Lucerne sells for more than $29,000. So maybe gold is a little low. But not much.

In a stable, prosperous and growing economy, $1,000 gold might be no bargain. But what about a world that is probably in a multi-year depression...that the feds are fighting with trillions of dollars' worth of new cash and credit? What about a world where the world's largest debtor is borrowing another $9 trillion over the next ten years? What about a world where the imperial power is losing its grip? What are the odds that something will go wrong? What are the chances that the feds will miscalculate? And what will happen if they do? Possibly, the depression will deepen...and $1,000 gold will seem too expensive. Possibly, the feds will add too much new money to the financial system, causing a new bubble in gold. Possibly, the Chinese will dump the dollar...causing the dollar and the US bond market to collapse.

Too many 'possiblies.' Too many things we know we don't know. And too many things we don't know we don't know too. And too many things about which we have no clue. We're tired of thinking about it.

Until the picture becomes clearer, we will stick with our trade...buy gold on dips, sell stocks on rallies.

Bill Bonner
for The Daily Reckoning Australia

• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• The Rally is On as the Dow Rises
• What Happens to Gold When High Inflation, Excess Cash, and Falling Dollar Jolts Economy?
• Paying More Than 3 Times as Much for Gold
• Gold and Silver Demand Unprecedented

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

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

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

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

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

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

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

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

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

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

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

Until next time,

Bill Bonner
for The Daily Reckoning Australia

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

US equities have just come off their best July since 1989. Overall, the market is up over 8% for the year.

But if we look backward (after all, hindsight is 20/20), March 1989 also saw a huge run up. It was followed by an even stronger rally in July, during which volume dried up. It appears the same is happening now. What came next in 1989 was a big sell-off in September, followed by an even greater one in October.

Don't look now, but history tends to repeat itself.

Also, consider the fundamental picture. We have rallied 48% from the March lows on the back of what? Good earnings? Good employment figures? Good spending figures? Expanding GDP? No.

We have rallied based on one of the largest and most concerted propaganda campaigns ever waged, supported by government stimulus. But no government can stimulate forever. The bottom line is this, if Americans do not return to work, THERE IS NO RECOVERY. Memorize this line. Post it on your refrigerator, your mirror, your dashboard - wherever!

So maybe now you're asking yourself, "Aren't the unemployment numbers getting better?"

Well, let's see...

Verizon - 8,000 jobs cut
Motorola - 7,000
Microsoft - 5,000
Untied Technologies - 8,000
HSBC - 6,100
Anglo American - 19,000
Avon - 2,500
Goodyear Tire - 5,000
GM - 10,000
Nissan Motors - 20,000
Panasonic - 15,000
PNC Bank - 5,800

Many of these will be released in the third and fourth quarters. No doubt there are plenty more we haven't heard from yet. Frankly, I couldn't list the thousands of companies and millions of jobs lost in this write-up. That's just a sampling. But let's get to some hard and fast figures.

According to Seeking Alpha, 13 million Americans will lose their benefits by years' end. So if unemployment claims are falling, people must be getting back to work. Right?

WRONG!

They are exhausting their benefits. There are 30 million people in the United States on food stamps. There are only 200 million working-age Americans (age 15-64). Is there any wonder why the Administration is NOW saying they will have to raise taxes on the middle class to fund their programs?

Unemployment has been estimated by many good economists as being around 20%. Unfortunately for these people, their nanny-government lifeboats are slowly running out of air.

Those 3 million people who lost their jobs in the second half of last year? Once you factor in their dependants, that equals 10 million people who have no income and no savings.

And how about the other 4 million others who lost their jobs in the first half of this year? They will be next. The numbers get so depressing, I hate to even count them up.

As I have said before, unemployed people don't spend money. They don't buy technologies, or durables, or even pay their mortgage. Bankruptcies are up 600% in this recent downturn. And that includes the time after Congress affected new rules to make bankruptcy harder.

So who is going to pay for anything when they are struggling to buy groceries?

If the equity averages are already rallying on the back of these horrible stats, there is nowhere to go but down when the real truth sets in.

And we have seen this corollary frequently in recent months. When stocks and risk assets fall, so do the currencies, and the dollar rises. We are a long way from being out of the woods on this retracement.

So why do I cite all this doom and gloom about the United States? Believe me, there's plenty more to go around. Because the fact of the matter is this: When these chickens do come home to roost, we will see another gut-wrenching breathtaking sell-off in equities, which will be followed by currencies. We have not seen the end of this yet.

While some are talking of a recovery, others are talking about a possible double-dip recession - and I'm reasonably sure we are in for a "multi-dip." It is hard to be bullish on the dollar for any reason, but if the market drops again, which I believe it will, funds will rush right back to the dollar (and the yen).

So far, we have seen range-bound trading in the recent months as currencies search for direction. This week the big news was the US GDP. Risk currencies rallied on the back of it, but for 24 hours they have remained flat as there were no buyers to move it higher.

Also, the market got awfully jittery on the release of the consumer spending news yesterday. The manufacturing euphoria expended itself, and now we find out that personal income has dropped 1.4%, the biggest fall in four years. Inflation-adjusted spending fell 0.1%. The real dark spots in the economy have started showing back up. The stimulus has worked its way and done its best, but its effects are now negligible. Even though there are signs of a "recovery," it isn't going to be one without the consumer. If he's exhausted his means of spending, or is just afraid to put out any money, the recovery trade will be doomed. And that means dollar strength once again.

But for now, we will have to trade with what we have. It is hard to argue with the markets, even with the most compelling of reasons. A person may as well try to stop an ocean wave from breaking onshore.

And as we look ahead, we must always be mindful of what may be. As numerous talking heads were saying on Tuesday of this week, "We have turned the corner... things are going to get better - if they don't get worse!"

Regards,

Bill Jenkins
for The Daily Reckoning Australia

• Investors Think Things Will Return to the Way They Were in the Bubble Epoque
• No Evidence of Recovery as Unemployment Getting Worse
• Economy Has to Grow at 1% to Stay Even With Population Growth
• The Business Bankruptcies and the Personal Bankruptcies
• Things That Matter in the Economy are Going in the Wrong Direction

Yesterday's issue of USA Today featured a report that said small businesses are going broke faster than expected. Small businesses are supposed to be the survivors. Like mammals in the Ice Age, they replace the dinosaurs. In a recession, big, costly, inflexible companies are supposed to get hit the hardest...leaving niches for small, nimble, low-cost competitors to slip into. These small businesses establish toeholds during the recession...hire people...and then scale up to the peak of commerce when the boom comes.

But this time it's different. Small businesses are collapsing along with big ones. In April, for example, more than small 8,000 businesses went broke and filed for Chapter 11.

In addition to the business bankruptcies are the personal bankruptcies. According to the Los Angeles Times, the rate of personal bankruptcy is soaring in Southern California.

In April, according to David Rosenberg at Gluskin Sheff, the feds added $121 million (at an annual rate) in total stimulus to the consumer economy - including tax reduction and increased benefits. In May, the total stimulus rose to $163 million. How come so many bankruptcies when the feds were giving away so much money?

The answer, says Rosenberg, is that consumers didn't spend the money; they saved it. Consumer spending rose just $1 billion April - despite $121 billion of stimulus. In May it rose $25 billion - despite a 'stimulus' 6 times that amount.

Meanwhile, the saving rate, which had been only 0.2% in March of 2008 exploded to nearly 7% in May 2009.

No consumer spending, no sales. No sales, no revenues. No revenues...no one can stay in business.

No small businesses. No new jobs. No new jobs, no economic recovery.

No economic recovery and the meddlers are back on the Hill asking for more power and money.

No surprise there.

Depressions take time. Bankruptcy rates don't rise overnight. First, it takes businesses a while to realize their sales are falling. At first, they think it might be a fluke. Then, they talk to friends and read the papers. And then, the next month confirms the story.

Then, it takes time for them to react. They have to figure out where they can make cuts. Typically, this involves layoffs and job losses. Employees who will be let go need to be identified. Then, they actually have to be sent home.

Then, the employee collects benefits. He looks for another job. He draws down savings. It takes time for him to react too. He watches. He notices that it is hard to find another job. He realizes his resources are running out. He begins to cut back. Unnecessary expenses are eliminated. Then, he broadens his definition of 'unnecessary.' Finally, he lacks the money for the essentials. The mortgage goes unpaid. Credit card deadlines are missed. This provokes an inevitable response - warnings, more warnings, official action, and finally...defaults, foreclosures and bankruptcy filings.

We expect unemployment and bankruptcy filings to edge up throughout the summer months. Then, by the autumn, asset prices should be going down again.

Bill Bonner
for The Daily Reckoning Australia

• Where, Exactly, is this Economy Headed?
• Normally Small Businesses Lead the Economy Out of Recession
• On the Evidence, Stimulus Programs Aren’t Working
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• Economy Has to Grow at 1% to Stay Even With Population Growth

The thought we kept having this weekend was an old one: that nothing is more dangerous than good luck.

As Bret Harte said, "The only sure thing about luck is that it will change." And it certainly has a way of kicking you in the derriere.

If you're lucky enough to win the lottery, you should watch your back. Almost all lottery winners are broke within a year or two. Many are broker than they were before they won the lottery. Because their good luck causes them to miscalculate.

There was a story about one lottery winner in the press here in London last week. He had won millions of pounds. Feeling lucky, he invested in a number of enterprises suggested by friends, relatives and total strangers - all failed. He married a much younger woman - who later left him (taking with her the house he bought for her). He invested on the advice of analysts and advisors - who naturally turned out to be idiots. And he lent money to people who, naturally, couldn't pay it back. He was in the news because he had been arrested for attacking one of his old friends while trying to collect a debt (he needed the money to pay his rent!)

Evelyn Adams won the New Jersey lottery twice - in 1985 and 1986. Talk about luck! She won $5.4 million in total. But don't go looking for Evelyn in a Beverly Hills or Palm Beach mansion. She lives in a trailer.

"Everybody wanted my money. Everybody had their hand out," she says.

Or take the case of William "Bud" Post. He won $16.2 million in the Pennsylvania lottery in 1988. Think he's fixed for life?

"I wish it never happened. It was totally a nightmare," says Post.

Within a year he was $1 million in debt and had to declare bankruptcy. Now, he is said to live on food stamps.

Niall Ferguson explains, in his book, The Ascent of Money, that it was good luck that ruined the Spanish economy of the 16th century. Indeed, we passed along the same basic facts here in the pages of these daily reckonings. Ferdinand and Isabella kicked the last of the moors out of Spain in the same year they sent Christopher Columbus across the ocean blue. Getting rid of the Muslims was a net loss to the Spanish; the moors took with them money...and more important...valuable commercial skills. But when the conquistadors arrived in the new world, they hit the jackpot.

One mountain, Mt. Potosi, yielded 45,000 tons of pure silver between 1556 and 1783. 'Valer un potosi' is a saying that is still used in Spanish to describe something that is worth a fortune. Even before the mining began, the Spaniards had helped themselves to billions worth of Aztec and Inca gold. Gold and silver were real money back then. The precious metals entered the Spanish economy and quickly inflated the money supply...first in Spain and then throughout Europe. The cost of living in England, for which there are some price records, went up 700% during the "price revolution" between the 1540s and the 1640s.

The "free" money coming from the colonies financed about 40% of the Spanish government's budget. But even with ships still bringing more and more gold and silver to Spanish ports, the crown still ran short of money. In 1557 it defaulted. And again in 1560, 1575, 1596, 1607, 1627, 1647, 1652 and 1662.

The US government now finances half its expenses with borrowed money. This is similar to the Spanish financing system, in that much of the money comes from outside the economy itself. But the difference is that the United States still has to settle up on its financing. Spanish gold was real money. It didn't have to be paid back. It was "monetized" from the very moment it arrived.

US financing is more subtle, and more complicated. But it is made possible by an extraordinary luck. The United States has the world's reserve currency...and the largest, most liquid economy. People put their money in US Treasuries because they are sure the money will be there for them when they need it. And they are used to a world of disinflation; interest rates and inflation rates have been falling for the last 25 years. And, inasmuch as the world economy is now in a deflationary correction, the risk of inflation seems very, very remote. So, for the time being, the United States seems to be able to borrow almost unlimited amounts of money at very low interest rates.

Bill Bonner
for The Daily Reckoning Australia

• Any Money That You Don’t Earn is Stimulus
• When it Comes to Economic Health, Nothing Beats a Depression
• Silver Stats That Will Make You Salivate
• Where Do the Feds Get Any Money?
• Summer of Awakening

Actually, we've seen so much already that it's hard to believe there's more coming. But there's sure to be more...and we have a feeling it will be worth the wait.

Yesterday, for example, GM filed for Chapter 11 bankruptcy protection. It couldn't pay its bills. GM was once the strongest corporation on the planet. But it has been around for nearly 100 years. Heck, everything wears out eventually...even a '55 Chevy.

"Obama Nationalizes GM," says a triumphant headline in France's La Tribune.

Triumphant?

Yes, according to the papers, Obama may have been handed the keys to GM...but the old jalopy is worn out. The French say the whole US economic model is ready for the junkyard. More on the French...and the French model, in our other article....

First, let's stick with the USA.

The Dow rose 221 points yesterday - to 8,821... Investors think the worst is over.

Everything is going up. Copper is up 65% so far this year. Oil is up 53%. Soybeans are up 22%. Stock markets are up about 30% worldwide. And gold is 12%. In this company gold is a laggard!

Copper has risen so much, say the papers, because China is buying all it can get. What it is doing with the stuff we don't know; maybe it is stocking up at what it believes are low prices.

Maybe it is hedging its bets. China has the biggest pile of Treasury bonds in the world - $768 billion of them. That's 768 billion reasons to worry. Because each T-bond is denominated in dollars...and while everything else is going up, dollars are going down. Yesterday, the dollar touched a new low against the euro for this year - at $1.42.

T-bonds are down too - minus 5% for the year. It would not be at all surprising for the Chinese to be stockpiling oil, gold, copper and all the other inflation hedges they can get. Their dollar-denominated bonds may go down...but their commodities and gold would go up. Overall, they'd come out even. You can also hedge your own nest egg with commodities.

Yet this week, Mr. Tim Geithner - the big banks' main man in Washington - is in China trying to reassure the Chinese that America takes its financial obligations seriously. That's something we never expected to see either. America may have the strongest economy on earth. But if the commies stop financing it, we're out of business.

So Geithner is in China, hat in hand, like a major debtor called into the bank president's office. Geithner, of course, has no choice. He has to go...and say what he has to say. He will use all the right words. He will show the appropriate seriousness...he will smile when it is called for...and put on a grave face when he needs to.

The trouble is, there's little he can do to help the Chinese. They want him to protect the dollar and the bond market. That's something he can't do.

"It will be helpful if Mr. Geithner can show us some arithmetic," said Yu Yongding, a former advisor to the Chinese central bank.

Yes, we'd like to see that arithmetic too. How do you add $1.75 trillion in deficits...pay for it with funny money from the Fed...and still come out even on the value of the dollar? There's no arithmetic we know of that works in the Chinese favor. Right now, the numbers...and the logic of the situation...are telling us that feds aim to create inflation. Instead of trying to keep prices under control...they're trying to get them to go up. That's yet another thing we didn't expect to see!

The US government is less concerned with protecting foreign lenders than it is with getting the US economy back to its old E-Z money ways. Cheap money is what people want. Cheap money is what the feds are trying to give them.

Today - will wonders never cease! - the US is pushing its phony money all over the world. The Chinese, meanwhile, are champions of financial integrity. Just wait until they give up on US bonds...then, we'll really see something we ain't seen yet!

Bill Bonner
for The Daily Reckoning Australia

• The Chinese and the Fed Both Buying U.S. Treasury Bonds
• American Family’s Share of Government Debt Now Over Half a Million Dollars
• Country Has Moved Towards More Government Intervention in Economy
• French Model of Economy Allows Meddling from the State
• China Has Stopped Stockpiling Metals

• Uncle Sam gets a 60% stake. The government will pump an additional $30 billion into GM (on top of the $20 billion already squandered). In exchange, the government will be the largest shareholder... leverage it will use to usher GM through bankruptcy and convert it to this "leaner, stronger company" we've been promised
• Half of the UAW's $20 billion health care fund will be converted to GM stock, which will give it a 17.5% stake in the company. 12-20 factories will be closed, at the cost of approximately 21,000 union workers. 40% of the 6,000 GM dealers will have to close, too
• The Canadian government gets a 12% stake, given all GM's design/manufacturing activity up north
• Bondholders were bought (bullied?) out. They'll swap their $27.1 billion in unsecured debt for 10% of GM, with warrants to own 15% more. Surely, they learned from Chrysler's bondholders, who were publicly vilified by President Obama for demanding what was lawfully theirs... so much for that hallmark of American capitalism
• Current shareholders get nada. At least that rule of bankruptcy is still intact. If you were long GM, please consider letting someone else manage your money. Anyone.

"GM Bankruptcy to Bring Taxpayer Ownership," headlined Bloomberg this morning. Shame on them and the US government for perpetuating this "taxpayer ownership" BS.

We must have been asleep when the "taxpayer" got any say in this one. GM is owned by wealthy politicians in Washington who, under threat of imprisonment, forced their constituents to finance the deal. Insinuating the public has any control is "Orwellian in the extreme" Addison suggested when we discussed the matter late Friday. Amen.

And let's be really honest... taxes haven't gone up to cover the GM bailout (or any credit crisis expense), but government borrowing certainly has. If any "taxpayers" truly own GM, their tax returns get mailed to Beijing and Tokyo.

Sign of the times... GM and Citigroup are getting kicked off the Dow. Cisco and Travelers will replace them next Monday. Extra irony (and foreshadowing?) in this exchange, as Citigroup is the former owner of Travelers, which it spun off in 2002.

The market had baked in GM's insolvency a long time ago. In fact, the Dow's off to the races this morning, even though one of its 30 components is rapidly approaching zero (the "beauty" of a weighted index). The big indexes rose 2% within the first 30 minutes of trading.

Ian Mathias
for The Daily Reckoning Australia

• Deal With Bondholders Cleared the Way for GM Bankruptcy
• The Chinese Stimulus Plan to Save the World
• Dow Jones Has Worst June Since Great Depression, American Model in Decline
• Obama Has Business Plan for the Car Industry
• Inflation Hasn’t Yet Reached the Wild Levels of the 70s

"You're just graduating from college, right?

"You wanna make some real money?

"Then, rush to Detroit. Set up a law firm specializing in bankruptcy."

More advice to college graduates follows...(below)...

Two auto-parts suppliers have already filed under Chapter 11. GM is expected to do so momentarily.

Too bad about GM. It was set up in 1916. If it had been able to hold together for another 7 years, it would have gone 100 years without having to declare bankruptcy.

All people die. All companies die, too. That's why 'buy and hold' is wishful thinking. Buy and hold long enough and you are sure to go broke. And die.

Eventually the undertakers and bankruptcy lawyers get you. And today...business is good in Detroit. What cleared the way for the GM bankruptcy was a deal with the bondholders...in which they take equity in exchange for their debt and agree not to contest the bankruptcy filing. Still, the deal - and other deals relating to it...including the presence of one very big and very odd shareholder, the government of the United States of America - is so complicated, it's bound to give bankruptcy lawyers plenty of work for many years.

But business seems to be picking up everywhere...at least, that's the impression you get from reading the paper. The war against capitalism seems to be going pretty well, in other words.

Yesterday, the rally continued on Wall Street, with the Dow up 103 points. Oil rose too. It is trading at $65 a barrel this morning. And look at gold - the old yellow metal is at $963 and still going up.

Does this mean the feds are winning the war?

"Signs of life return to California market," says the Financial Times.

Houses in many areas are selling for 60% less than they did two years ago. Two years ago, the average family couldn't come close to buying the average house. In didn't take a genius to figure out that that couldn't last. Who were they going to sell the average house to if not to the average family? Well, now the $600,000 dump from '07 has been foreclosed and is now on sale for $200,000. That means that the average family that still has a job can buy it.

And it doesn't hurt that the feds make it easier - distorting the market with an $8,000 tax credit and EZ financing from the FHA.

Wait a minute! Wasn't it easy financing that got us into this mess? Of course it was. But that little insight doesn't stop the feds. They're convinced that if they can just put out enough new credit, it will somehow make the problems caused by having too much credit before go away.

So here's the deal. You can get the FHA to finance a house, long-term, at just 4.9%. That's just 0.3% higher than the long-term Treasury yield. Even without opening the closet door, we smell a rat. How can lenders expect to make any money - after delinquencies, defaults, foreclosures, resales...to say nothing of legal and administrative work - on a 0.3% margin? And that's assuming their cost of money is the same as the feds' cost - the long term T-bond rate.

Maybe they should read the paper. John Authers, writing in the Financial Times:

"The latest US mortgage delinquency figures are horrendous, with more than 6% of prime mortgages in arrears - more than double the long-term norm. A quarter of sub-prime loans are delinquent."

And although one in 6 homeowners is underwater...

"The peak of foreclosures has yet to come,' Harvard historian Niall Ferguson adds. 'They will go from 40 percent of all home sales to literally 100 percent by the end of the year.'"

Well, the bankers - as everyone knows - are a lot smarter than we are. They're probably up to the old trick: borrowing short, lending long. The spread between the long rate and the short rate has never been great. We explained why yesterday. The Chinese don't trust Tim Geithner to keep his word. For that matter, neither do we. They've switched from buying long bonds to buying short bills. So, the bankers - including those working for the FHA - can borrow very cheaply in the short-term market. And they can make cheap mortgage loans, long-term. And then, when the short rates go up...and they need to roll over their short- term loans...they can get in line at the courthouse, behind GM and the parts manufacturers...

..and pick out a gaudy casket too.

Bill Bonner
for The Daily Reckoning Australia

• Being a Homeowner is the Beginning of House-Induced-Bankruptcy
• GM Insolvency Can’t be Run-of-the-mill
• The Family Office
• Ireland Going Through Same De-leveraging Process as the US
• Gorgon LNG Deal with China a Really Big Deal