The Simpleton's Analysis:

Consumers cut back. The economy sank.

Now, government must take action. It must help people out and take up the slack.

The downturn took $12 trillion off Americans' net worth. The feds have pledged about $12 trillion to fix the problem.

But wait, where does government get any money?

Hey, they borrow it, just like consumers did. And besides, it's ultimately the same money - taxpayers' money. So what's the big diff?

The big diff is the subject of today's Daily Reckoning.

The first big diff is that the feds don't spend your money the way you would. Private citizens spend money they don't have on things they want but don't need. The feds spend money that doesn't belong to them on things that the rightful owners don't even want.

Wait a minute. Markets were closed yesterday. With no figures to report, we should talk about something important. What's important about macroeconomics? Nothing. It's 95% claptrap. The other 5% is pure fraud.

At least as practiced by the leading macroeconomists of our time - such as Ben Bernanke, Tim Geithner and Larry Summers. It's just a show-off sport...the idea is to impress the world with some fancy data-heavy formula...win the Nobel Prize and save the world. That way, you get what all men crave...money and power. Why do men (and women) want money and power? Aww, c'mon...we explained it already. Because it improves their chances of survival and procreation. In a DNA study, for example, they found that Genghis Khan, today, has something like 6 million male descendants. Is that success or what?

The great Khans of today are no longer the steppe warriors on horseback. They're basketball players, rock 'n' roll stars, actors, and hedge fund managers...and, oh yes, occasionally - economists.

The link between economic theory and procreation is probably very weak; but that doesn't stop economists from wanting to strut around and show off. And the way for an economist to show off is to get himself appointed to the President's Council of Economic Advisors...or to the central bank...or get a professorial post at Princeton...etc. etc. This you do by producing tomes, formulae and hypotheses. And, don't forget to write a piece for The Wall Street Journal from time to time.

Another important hint: your work has to suggest that you can manipulate the business cycle, control the credit cycle, or generally make things turn out the way people want.

If you are a Daily Reckoning-type economist, you can forget fame and fortune completely. Who wants to hear from a macroeconomist who tells people to leave well enough alone...and to let the forces of natural economics sort out their own problems? No one...at least no one who is running for public office. Instead, they want someone who will promise to "Save the World."

Save the world from what? Why...from the damage done by other economists!

Two generations of American economists thought the way to bring prosperity was to encourage consumption. On the face of it, the idea is absurd. Classical economists...and Daily Reckoning commentators...laugh at the idea. You don't really get rich by consuming; you get rich by saving and investing.

But they had their charts and graphs...their theories and their jobs teaching economics at prestigious universities. Naturally, they had the feds' ears too - since every politician wants to promise more consumption. The feds favored home ownership, for example...even by people who were bad credit risks. They set up Fannie and Freddie to make it easy for people to buy houses. They even passed a law requiring banks to lend to people who weren't likely to pay them back; that was the origin of the sub-prime mortgage market! They kept interest rates low, too, so people could borrow at affordable rates. And they inflated the currency, so consumers would want to spend their money rather than save it. They also opened the world to free trade, so Americans could buy more, cheaper stuff made by foreigners. For 50 years, they cultivated consumption and let production go to seed.

And now...wouldn't you know it...Americans have over-consumed. Personal expenditures per capital rose 25% between 2003-2005. Personal debt soared to over $13 trillion...about $124,000 per household. Total debt/GDP tripled since 1980.

And now, it's payback time. The private sector has cut back. Consumers need to under-consume to make up for the over-consumption of the bubble years. Savings rates are rising. Spending is falling (see below)...

And so what do the simpletons do? Private citizens are unwilling to consume...so they push the government to consume their money for them!

Bill Bonner
for The Daily Reckoning Australia

• Where Do the Feds Get Any Money?
• Baby Boomers Face Early Retirement With No Money Saved
• Feds’ Plan is to Reflate the Economy
• Why Weren’t Economists On Top of This Thing?
• 2009 Federal Deficit Could Go As High As $2 Trillion

We were thumbing through the transcript last night over some sashimi and a beer and highlighted this passage from Dr. Steve Keen: We are told that for example debt doesn't matter because if a company takes out a certain level of debt, say a very low level of say 10% debt to equity, that's irrelevant to the company's value because the person buying shares in that company can take out 90% debt to equity ratio."

"Therefore you're told the Modigliani-Miller proposition, after the two morons who got the Nobel prize for it, was that the level of debt that a company takes out does not affect its value. And those sorts of propositions are strewn through conventional economic theory, and of course people like Alan Greenspan and Ben Bernanke are experts in that very same theory."

See? Bernanke...Greenspan...morons, all of them! Debt does matter. And so do deficits. Just this morning we read that U.S. President Barack Obama will ask the Senate to lift America's statutory debt limit to $13 trillion. It's at $12.1 trillion at the moment.

The lower legislative body of the Congress, the U.S. House of Representatives, passed a measure lifting the debt ceiling earlier this year. But it used a parliamentary trick to do it in a manner which did not require a roll call vote. No jack asses had to go on the record.

The Senate is different. There are just 100 of the grumpy old men and women. And to increase the debt ceiling to accommodate annual deficits of over $1 trillion for the next ten years (it's $1.6 trillion this year) the Senator will have to go on record. Spending other people's money is generally easy (and probably kind of fun). But not when you have to publicly commit to it and "own" the debt. No one wants to own it, even though everyone wants to benefit politically from the spending (sound familiar?)

The investment fallout from the record U.S. debt and deficits is continued pressure on the dollar and $1,000 gold. Old yeller metal dragged itself up $2.50 in the futures markets to close over the $1k in New York trading last night. Gold has done this despite a 50% rally in stocks. We reckon once the punters catch a little gold fever - which they will if it can hold the line at $1,000 for a few days - higher highs will follow.

And let's not forget large owners of dollar-denominated assets like stocks and U.S. Treasury bonds. Do you reckon they're getting a touch nervous? Cheng Siwei, a Chinese official attending a conference at Lake Como in Italy, said he was worried about the Fed's indefinite policy of credit easing.

"If they keep printing money to buy bonds it will lead to inflation," Chen said. "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... 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."

In the meantime, why not try iron ore and uranium? Reuters reports that, "Chinese state-owned firms expanded their footprint in Australia's mining industry on Tuesday, agreeing to help fund two iron ore explorers in return for supply contracts and taking a controlling stake in a uranium prospector." The iron firms involved were FerrAus United Minerals both of which formed relationships with China Railways Materials Commercial Corporation. The uranium deal was between China Guangdong Nuclear Power Holding Co. Ltd and uranium prospector Energy Metals.

These deals are probably both operational and strategic. They're operational to the extent that in exchange for capital, Chinese firms get long-term supply contracts (price certainty) for key minerals and bulk commodities. They're strategic to the extent that State-owned firms can channel U.S. dollar reserves into tangible assets. This slightly reduces China's risk to the inevitable devaluation of U.S. debt securities through inflation.

Getting back to Cheng, he seems to understand exactly what happened over the last five years. Loose credit is the problem. "This is where Greenspan went wrong from 2000 to 2004," he said. "He thought everything was alright because inflation was low, but assets absorbed the liquidity." He's talking about real estate and stock markets.

He's also talking about the psychological and moral attitude in a country that's obsessively focuses on preserving its immediate lifestyle at the expense of future investment and growth. "The US spends tomorrow's money today...We Chinese spend today's money tomorrow. That's why we have this financial crisis."

Of course whether your Chinese, American, or Australian, it's everybody's crisis now. So what should you do?

Inflation has yet to really rip through the commodities sector. As Bill pointed out yesterday, the U.S. dollar has yet to really crash. It may do so only gradually. U.S. creditors are not exactly easy to cause a run on the dollar. They have a lot to lose. And we know the Fed and Tim Geithner and Barack Obama want a gradual devaluation, not a dollar crisis.

Will they get what they want? We don't know. But we reckon the Law of Perverse Outcomes applies here: people get not what they expect, but what they deserve.

For investors, we'd say again that markets are priced for earnings growth that we think won't materialise. It's wishful, almost nostalgic thinking. That means you should be on your guard for locking in paper gains since March with trailing stops. We're pleased that Gabriel Andre is just about ready to debut his new ASX 200 blue-chip timing service this week. The aim is to track the chart patterns and technical trends on the biggest Aussie stocks in order to avoid buying at the top.

But the big benefits - he hopes to prove - are the ability to take profits on long-term holdings and avoid the big declines we've seen over the last two years. Then, using the same analysis, Gabriel believes you can time your entry back into the same stocks. It's quite a proposition.

Of course, anything that looks or sounds like market timing probably makes a buy-and-hold investor really nervous. But it's time to question the conventional wisdom that buying and holding blue chip stocks is a guaranteed retirement strategy. It's not.

If we've learned one thing in the last two years, it's that the stock market is not a retirement machine. The name of the game is to generate gains. And we are at least open to the idea that it may be possible to make better gains as a medium-term trader of ASX 200 stocks than simply buying and holding for grim death.

On the other hand, there are some very exciting disruptive energy technologies that have a huge upside if you can stomach the risk. Woodside Petroleum Don Voelte took a swipe at those technologies in a recent article published locally. And for good reason. He's got a bit to worry about. More on disruptive energy technologies tomorrow...

Dan Denning
for The Daily Reckoning Australia

• American Family’s Share of Government Debt Now Over Half a Million Dollars
• The Very Large Bubble of Government Debt
• Uranium: A Carbon-friendly Substitute for Coal
• In a Bear Market Most Stocks Go Down, So What Do You Do?
• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis

But first, we were poring over the reader e-mail last night. Many readers think we are being unfair, unconstructive, and un-brief in our critiques of Ben Bernanke, bankers, Kevin Rudd, and other economic know-nothing from across the political spectrum. So let us take a moment to be as clear as possible: policy makers and politicians are morons.

We're told Ben Bernanke is the right man to get us out of the trouble we're in. But isn't Ben Bernanke the man who got us into the trouble to begin with? Didn't he and Alan Greenspan lower interest rates so much they created a worldwide credit boom that is now deflating? Wasn't it their policies that enabled banks and Wall Street to securitise commercial and residential mortgages and send them far and wide into the balance sheets of the world as "assets"? And aren't those "assets" now falling in value, continuing to wipe out equity at the household and corporate level?

It is clear that politicians are still slovenly serving the interests of their corporate masters in the financial world. And it is clear that the financial world has every reason to encourage government stimulus, loan guarantees, and lower interest rates. This keeps the great leveraged credit machine of the Financial Economy motoring. And that machine keeps the financial industry in tall cotton.

Besides, the limits on executive compensation are window-dressing for public (voter) consumption. With bonuses limited by statute, we reckon more compensation for the financial industry will move back to stock option grants. That means for the financial industry to preserve its privileged status, stock prices have to move higher. And nothing enables that like credit. Borrow money and plough it back into stocks to line your pocket. Does that sound like something that may be happening?

Our point is that this whole interlude since the collapse of Lehman Brothers is an attempt to preserve the status quo ante. If the tools of monetary and fiscal policy (which are clumsy and theoretically flawed anyway) exist to make the financial and estate industry thrive, the real economy will continue to get screwed. We'd argue this recent recovery is nothing but an attempt to resuscitate the money-shuffling arrangement that was so profitable up until late 2007.

At least some people agree. "A UN think tank on trade has warned that the current financial market rebound is not a 'real recovery' and that any world economic growth recorded in 2010 was unlikely to exceed 1.6 per cent," reports today's Australian.

"The depth of the recession has been so important that of course there will be a rebound ... but we still do not see that this is a real recovery," says Supachai Panitchpakdi, secretary-general of the United Nations Conference on Trade and Development (UNCTAD). "The actual increase in the commodities prices is mainly driven by appetite for more risk," he says. More on this in just a second.

UNCTAD's Chief economist Heiner Flassbeck, said, "the markets had been fuelled by financial speculation that in turn was driven by expectations of recovery. 'But anticipation of recovery is just a fiction, it is not there.'"The UNCTAD report also noted that, "Tumbling profits in the real economy, previous over-investment in real estate and rising unemployment will continue to constrain private consumption and investment for the foreseeable future."

Hmm. Maybe UNCTAD is reading the Daily Reckoning. But if not, for those who have eyes to see it, the truth is plainly in sight. You cannot correct the global imbalances of a leveraged boom with more leverage. But let's tackle on specific aspect of the report that suggests commodity prices may again be the subject of financial speculation. Is it true?

Frankly it's hard to say. We're more confident that profits in the real economy - once you take away the effect of credit and government money - are regressing to an historic mean. Some companies will make more. Some less. But the average will be lower.

However we did see one interesting chart yesterday from our trader Gabriel Andre. We were discussing with him whether the euphoria about Australia - the dollar, the stock market, real estate, and commodities - was suspiciously reminiscent of June 2007. You know, right before the ore hit the fan. Is all this feel-good news a sign of worry?

We decided to tackle the question with a picture. It's the chart you see below. The chart tracks the performance of Worley Parsons - a proxy for infrastructure and capital spending in the mining industry - versus the CRB commodity index. We are asking a question with this chart. The question is, does a peak in Worley's stock presage a downturn in the resource sector generally?

Click to enlarge

Gabriel writes that, "The level of $30 looks as a strong resistance for the stock. It's a previous low where it bounced back several times in 2007 and 2008. The recent action suggests the $30 may be a new high, finding resistance, especially because the correlation is obvious with the CRB and the CRB has already started correcting.

"If you pay attention to the details on the chart, it looks like the correlation is stronger on the downside. Worley can fall when the CRB rises. But when the CRB falls, Worley generally falls too. If you were asking me to turn this observation into a trading idea, it would be to short-sell WOR at the current levels with a stop-loss at $31. A correction towards $20 is possible.

Gabriel has been working on a system to trade these chart patterns in ASX 200 stocks for the last four months. Look for more information on that later this week. And in the meantime, keep in mind that if Worley is a proxy for the bull market in Aussie resource stocks, the charts are suggesting that all the positive momentum since March may be reaching its limit. When you check in the turn down on the CRB, you should be prepared for the possibility of a correction in commodity prices too.

If that happens, it would be perfectly consistent with the tenor of the news these days. As excited as we are ourselves about certain resource projects, the level of bullish consensus about commodity prices and corporate earnings is a warning sign. But - this is important - that doesn't mean you have to head for the hills.

As Gabriel's work is showing, you can use these kinds of signals to take profits before rallies expire. It can also save you from mis-timing your entry into a blue chip share. And ultimately, it should be able to help you identify the best time to get back into the share, after the inevitable correction has done its work.

We meant to write more about gold, sound money, and unsound economic thinking. But that will have to wait until tomorrow. Until then...

Dan Denning
for The Daily Reckoning Australia

• CRB Index Correction Likely to Go Further
• Worley Parsons (ASX: WOR) Announces Pilbara Solar Energy Project
• Note to Australia: Buy Resources, Not Banks
• Government Preparing Another Stimulus
• Recovery for the Real Estate Market

Probably most incredible is that the dollar has NOT collapsed. It has lost ground, and was trading at $1.43 per euro on Friday, but no one laughs at you when go to exchange dollars...or offer to pay in dollars rather than the local currency.

For the last 10 years, the money supply in the United States has expanded at roughly twice the rate of GDP growth. And the Fed doubled its balance sheet in just the last 18 months. This last bit of information is stunning. It took the central bank nearly 100 years to build a balance sheet of $1 trillion. Then, under the leadership of Ben Bernanke, it added another $1 trillion in just a few months.

What does that mean, exactly? It means they bought a lot of debt from US agencies and the financial sector. It means also that they "monetized" this debt...transforming it into cash by paying for it with money especially created for that purpose. It also means that the whole financial sector has a bigger financial base against which to lend. The Fed lends against its balance sheet to member banks. These banks then lend to other banks who lend to business and consumers. So the amount of potential credit - as well as the amount of actual cash - has gone up.

There is an iron law in economics. Quality and quantity vary inversely...which is another way of saying that when you add more of something...each unit is worth less than the unit that preceded it (assuming everything else remained unchanged.) Certainly, this is true of money. The more money in a financial system, the less each unit of it is worth. Add enough new money - as Zimbabwe proved recently - and each unit becomes worthless.

But so far, the dollar has not collapsed. It has fallen, but gently...

Meanwhile, the inflation rate has NOT gone up. Instead, it's gone down. Go figure. You add that much monetary inflation and you'd expect to get a boost in the CPI. Nope. Not yet.

On the other hand, we're already a year-and-a-half into a major recession/depression. You'd think you'd get deflation. That hasn't happened either. Prices are down. But not as much as you'd expect, given the scale of the downturn.

Related to both the dollar and inflation is the bond market. Even more surprising is that the bond market has NOT fallen apart. Let's see, a huge input of monetary inflation; that ought to kill the bond market. Then too, the biggest sales of Treasury bonds in history - needed to cover a $1.7 trillion deficit this year. That ought to kill the bond market too. And on top of it all is a projection from the White House telling us that the feds will add $9 trillion to US debt over the next 10 years. And that assumes a full recovery in the economy! Now, that ought to kill the bond market for sure.

Not at all! Bond yields have risen...but the 10-year T-note still only gives you 3.4%.

Of course, you say, it's a depression. Bond yields always go down in a depression.

But if it's a depression, how come commodities are up? And stocks are up? Above all, how come Chinese stocks are up? Everybody knows China earns its money selling products to Americans and other non-Chinese. If the rest of the world is in a depression, who is China going to sell to? How come China isn't in a depression already? But there you are - there's another thing that hasn't happened. Chinese stocks haven't collapsed.

And getting back to commodities, they're all up. Commodity prices don't go up in a depression; everybody knows that. They go down. But commodities are NOT in a bear market. Go figure.

And, of course, there's gold. The metal gave up a dollar on Friday, but it's still just $4 short of the $1,000 mark...and just a shadow below its all-time high. Gold is a commodity...but it's also money in its purest, more reliable form. Commodities go down in a depression. Money goes up. But since gold is an alternative to paper money, it tends to go up only when paper money goes down. As explained above, the dollar has NOT collapsed. So why is gold going up? It should be going down, reflecting the effect of a recession...

There are two possible answers.

First, maybe the iron laws of economics have been repealed.

Or, second...maybe the iron laws just haven't caught up to the market - yet.

Unemployment is at 9.7%. It will probably rise above 10% this month. The economy is supposed to be recovering. Now, The New York Times is talking about a "jobless recovery."

You'll remember the phrase. It came out in 2003. Then, the economy was allegedly recovering from a micro-recession. Economists were surprised that there were so few new jobs created.

What was really happening was that there was no genuine recovery. Consumers just decided to go deeper and deeper into debt - egged on by the feds. A regional governor of the Fed actually urged consumers to "go out and buy an SUV." So Americans bought more products from the Chinese...on credit...and the Chinese enjoyed a boom.

And now the boom is over. Americans are paying down their debt. And unemployment is getting worse. This time the feds are pumping trillions into the system. This time, it's not the consumer who is willing to go further into debt; it's the government. And once again, few new jobs are being created.

Without jobs, the recovery is an impostor...a phony...a fraud. Without jobs, people have no extra spending power. So they can't buy - except by going deeper into debt. They were willing to go further into debt in '03-'07. But not this time. They've reached their limit on debt. Besides, with house prices falling, who would lend to them?

No new jobs = no new income. No new income = no new sales. No new sales = no new profits = no new jobs.

But what about the government? The feds are still willing to borrow. How come federal borrowing can't create a new boom - even if it is a phony one - like the one in 2003-2007?

Federal borrowing, spending, bailouts and monetary inflation are not helping the real economy. But they are making a lot of money available for speculation. That's why so many things are NOT happening. Investors are speculating on commodities, gold and Chinese stocks - for example. And US bonds.

But this is not a durable, reliable trend. And it's not laying the foundation for a genuine recovery. Borrowing by the feds is different from borrowing by individuals. Private households can go broke. But they can't take the dollar down with them. When the feds borrow, they pledge the full faith and credit of the United States - and its currency - as security. So, as they borrow more...the value of the US currency comes into doubt...then, into play...and then into jeopardy.

Investors eventually sell off dollars and US bonds...then, what should happen finally does.

Caution: what has to happen does eventually happen. But it doesn't have to happen when you think it should. The big surprise might be how long it takes before these things happen. If we were Mr. Market, for example, we probably would not take gold much higher - not just yet. We'd let deflation take gold down for a while - long enough to separate the speculators from their money. Then, we'd let investors get used to falling prices - before bringing inflation back.

Bill Bonner
for The Daily Reckoning Australia

• Where, Exactly, is this Economy Headed?
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Gold Doesn’t Always Need Inflation to Rise
• Fed Will “Monetize the Debt”
• We Expect No Recovery from the Economy

It's back to business. No more long lunches. No more afternoons painting windows. No more soirees in the evening.

We return to our lonely métier - chronicling the decline and fall of the US economy...and the Anglo-American empire too....

Two bits of news signal the scale of this trend. But first, here's one two-bit piece of news: the Dow lost 185 points yesterday. Could this mark the beginning of the end for the rally? Yes, it could. Should you be out of US stocks? Yes, you should.

But let's turn back to our 'decline and fall' chronicles...

From Florida, comes news of the first drop in population in 60 years. "Unemployment is soaring," reports USA Today. "Florida is second to California on foreclosures."

Yes, dear reader, there is trouble in the sand states...

Florida lost a net 58,000 people this year...for the first time since the 1940s.

Why would that be? We'll take a guess. Florida is a state where people go to retire. It is where people go when they stop producing and begin consuming. The major industry in the state was housing...building houses for consumers!

But now, the turn has come. Fewer people have money to consume. And those who do are keeping their money in their pockets. We even saw a report in The Wall Street Journal that people are cutting their own hair to save money. They're also staying put, rather than moving to Florida. So Florida needs fewer new houses...and fewer people to build them.

Second, from national income statistics comes a report that the typical US household has less discretionary spending than at any time in the last 50 years. Why? Americans have no money to spend because they already spent it! Now they're paying the price. And it will take years - maybe 10 years, maybe longer - before they've paid down their debts to more comfortable levels. In the meantime, they are poorer than they've been since the Eisenhower years.

Keeping it simple: Our view is that there is a major transition underway. There will be no genuine recovery, not now...not never. That is not to say the world economy is doomed to perpetual darkness and misery. Not at all. What it's doomed to is a long period of adjustment...with high unemployment, on-again, off-again recession, and desperate efforts by the feds to return to the good old days of the bubble years.

But there's no going back. It was as if the economy was playing a game of Russian roulette...and then the pistol went off - the debt bubble blew up. Once the bullet left the chamber, the game was over. Recovery? Forget about it. The old economy isn't going to bounce back; it's dead.

Still, just because a thing is hopeless doesn't make it unpopular. The feds are fighting the correction every step of the way. They're propping up brain-dead companies...and keeping zombie banks going by feeding them the blood of taxpayers. It's ghoulish...it's a very scary movie!

Unfortunately, the ghouls vote! And everywhere the feds look there's a campaign contributor or a lobbyist or a voter...and they all want the A-positive blood of taxpayers. They look to the feds for a transfusion in order to keep living in the style to which they've become accustomed...

Just what you'd expect, in other words. And with so much debt in the system, the feds are desperate to raise inflation levels. They must increase the CPI to persuade consumers to spend money rather than save it. Otherwise, the nation risks falling into a deflation trap - the very thing Ben Bernanke has pledged to avoid. So they'll continue going down that road - towards inflation - until they finally get there. And they'll keep pressing harder and harder on the monetary accelerator until they finally run into a tree. Again, just what you'd expect.

So, where's the surprise? We're on the road to destruction; that's clear. But it may be a much longer road than most people expect.

Ambrose Evans-Pritchard in London's Telegraph:

"'The current financial crisis is unlike any others,' says the Bank for International Settlements. Lasting damage has been done. The 'cumulative output loss' is likely to reach 20pc of GDP in the major economies.

"The message is the same at the International Monetary Fund. 'The world is not in a run of the mill recession. The crisis has left deep scars. In advanced countries, the financial systems are partly dysfunctional,' said Olivier Blanchard, the Fund's chief economist.

"It has certainly alarmed US retail tycoon Howard Davidowitz. 'As a country we are out of control, we're in a death spiral,' he said.

"Jeff Wenniger from Harris Private Bank says an army of baby-boomers have seen their old age plans shattered by the housing bust. Their nightmare is here. They will have to spend less, and save more. 'Generational destruction of a society's balance sheet will not rectify itself in a matter of months.'

"'How about a quarter century?'"

Bill Bonner
for The Daily Reckoning Australia

• Economy Not Going Back to Normal Any Time Soon
• Baby Boomers Face Early Retirement With No Money Saved
• Feds Want to Increase the Money Supply and Induce People to Spend Money
• Should You Buy Gold Now?
• Until This Debt is Reduced, Americans Will Be Reluctant to Borrow or Spend

This week, Ben Bernanke got the nod for another stint as head of the world's most important central bank. Yes, he completely misunderstood the implications of the hugely negative US trade balance, believing that America did the world a favor by spending its "global saving glut." And, yes, he missed the approach of the biggest financial disaster in three generations. Then, when it arrived, he mistook it for a routine recession, until finally, panicked by the collapse of Lehman Bros., he insisted that Congress pass a $750 billion spending bill - or "we may not have an economy on Monday."

But except for things that really matter, he's been a pretty good Fed chief. Besides, he has the right credentials. He was a professor of economics at Princeton and holds a Ph.D. from MIT - just like the most recent Nobel Prize winner in economics, Paul Krugman.

The United States has just averted the Second Great Depression, say the papers. "What saved us?" asks Krugman in a recent New York Times editorial. "Big government," is his answer. Specifically, the big government of Ben Bernanke.

But the ghost of Milton Friedman haunts the central bank. Bernanke borrowed a phrase from Friedman, saying he'd even "drop money from helicopters,' if necessary, to prevent deflation. This led to one of the surest trades of the Bubble Era was the so-called on the 'Bernanke Put.' Investors thought they could count on him. Buy stocks. If they went down, Ben Bernanke would make sure you didn't lose. He'd add liquidity until the market bounced back. But the Bernanke Put trade went bad in '07. The market fell. Ben Bernanke added liquidity. But so far, stocks have yet to regain 50% of what they lost. Meanwhile, consumer prices are falling. And yet, he does not drop money from helicopters. Why not?

Few people would have more authority on the subject than the group gathered at the Beverly Hilton in Los Angeles earlier this year. Michael Milken, the Junk Bond King, gathered them thither and picked up the tab for Gary Becker, Myron Scholes, and Roger Myerson...each of their names is preceded by 'Nobel Prize winner.' With that kind of brainpower on hand, you'd think you could come up with a good explanation. But the best they could do was a simple analogy. Gary Becker (Nobel awarded '92) took the Friedman line; he argued that by putting out the little forest fires, the recessions of the '90s and the early '00s, the feds inadvertently created the conditions for an even greater conflagration. Instead of burning off the underbrush, the tinder built up until a huge blaze was inevitable. And in a speech honoring Friedman, Bernanke accepted Friedman's criticism of the Fed in the '30s. Yes, Bernanke admitted, the Fed made mistakes; but we won't do it again, he said. The burden of today's rumination is that he was wrong; he will do it again.

"Inflation is always and everywhere a monetary phenomenon," said Friedman. But deflation doesn't seem to be a monetary phenomenon at all. Despite huge inputs of new money from the Fed, prices are still going down. The Fed's balance sheet more than doubled in the last 18 months. It will probably double again - to $4 trillion - before Bernanke's next term is over.

Friedman won a Nobel Prize for his work. And he drew around him a community of scholars that won so many Nobel Prizes they ran out of room in the University of Chicago trophy cabinet. But it only makes you wonder about the Nobel committee. Friedman's acolytes won their prizes for elaborating a series of mathematical proofs for things that were either self-evident or self-evidently absurd. Most of them were later shown to be wrong, irrelevant or misleading. Modern Portfolio Theory, Black-Scholes Option Pricing Model, Dynamic Hedging - the farther afield the scholars went, the more they lost touch with home. The more scientific their work became, the more it resembled alchemy or phrenology.

Friedman's work itself was flawed in the same way. The general principle was correct - that the government that governs the markets least governs best. But when he got into the mechanics of 'monetarism,' he got lost. He believed that if the Fed kept its eye on the money supply; the free market would take care of everything else. But the free market didn't take of everything, at least not as people hoped. Economist Murray Rothbard explained why in 1971. You cannot expect the free market to function perfectly if you leave in the hands of the government the power to control money. Either markets are free or they aren't, was Rothbard's point. If they're not free, you can't blame freedom when they fail.

But free market economists are now blamed for everything. The free- market Chicago boys are out. The MIT crowd is in. And investors are buying the Bernanke Put again, confident that the Fed chief will keep pushing money into the system and stocks will continue rising. But Ben Bernanke, for all his bluster, is a victim of the trade. Everyone knows what he is up to. They can't help but look ahead and see where it leads.

As soon as Bernanke starts his helicopter engines, bond buyers get out their missiles; the Chinese - the biggest single customer for US debt - have warned that they will shoot him down. What can Bernanke do? He is damned if he doesn't. But even more damned if he does. He can't guarantee increases in either CPI or stocks. All he guarantees is that Big Government will play a larger role in the economy...and that Milton Friedman's history of the Great Depression will turn out to be prophecy:

"The Fed was largely responsible for converting what might have been a garden-variety recession... into a major catastrophe..."

Ultimately, Bernanke does what his predecessors at the Fed did in the '30s...and what the Japanese did in the '90s. He hesitates. He makes mistakes.

And he wonders why he took the damned job in the first place.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Ben Bernanke Pays Homage to Milton Friedman’s Theory
• Barack Obama and His Nobel Peace Prize
• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• Ben Bernanke Averts a Second Great Depression

According to the popular version, Ben Bernanke, our flawed hero, has averted a Second Great Depression. When the crisis came in '07-'08, he calmly took out the text he had written himself: "Dummies' Guide to Avoiding a Japan-style Deflation"...or something like that.

Then, he followed his own theory...coolly...confidently...cutting Fed rates down to nearly zero, pushing Congress to pass a huge 'stimulus' bill, and even forcing Bank of America to take over Merrill Lynch. In this last event, he is accused of deliberately hiding Merrill's enormous losses and then threatening the BofA board with dismissal if they refused.

Because of Bernanke's swift and assertive action, the nation's banking system held together during those critical weeks of late 2008. And because of his monetary (and fiscal) policies, all the worlds' economies are now in some stage of recovery. Stocks are rising. House sales are increasing. All the indicators point to a better world.

In recognition of the fact that he saved the world, Ben Bernanke was given the nation's highest honor; Obama picked him to continue as head of America's central bank, the Federal Reserve...even though his predecessor, a Republican, appointed him.

Everyone needs a story. It's the way we understand things. Data is just data. Numbers are just numbers. Facts are just facts. Without the framework of a good tale to hold them together, they are worthless.

That's why, here at The Daily Reckoning, we are suspicious of facts, data and numbers. As for the numbers, they are wrong before they get to us...often intentionally. Then, when they are later straightened out, they sometimes tell a completely different story. Even the 'facts' often turn out to be not facts at all...but distorted data, information has been twisted to fit into a storyline.

The more precise the data, meanwhile, the more they lie. Give us a CPI rate of 6.24% and we will give you back two numbers that are total fictions...and another one that turns out to be wrong later. As for the GDP growth rate...don't even bother to give us a number at all. Whatever the digits say, it's a lie.

This week came news that the GDP is falling at a 1% rate. This number surprised economists. They thought it was falling at a 1.5% rate. This better-than-expected number encouraged investors to buy stocks; the Dow rose 37 points yesterday. Oil and gold remained more or less where they were.

Economists are frequently surprised. In a study of GDP forecasts, a researcher found that economists did nothing more than extrapolate current trends into the future. If the GDP was growing at 2%...they projected that it would grow at 2.3% the following year. Or maybe 1.9%. These projections were mostly correct. Generally, one year is a lot like the year before. But whenever the direction changed dramatically, economists missed it completely. In other words, they're not really capable of telling us what the economy will do - unless it does nothing different.

We've discussed the emptiness of the GDP figures many times. Just because the GDP is growing doesn't mean people are really any better off. In fact, GDP growth during the Bubble Epoque was really a measure of how fast people were ruining themselves. Seventy percent of the GDP was consumer spending; as consumer spending went up so did debt. The result was a paradox and a shame - at the end of one of the longest periods of uninterrupted GDP growth in history, the typical householder was poorer than he was than when it began.

That's why we are skeptical of numbers...especially precise numbers. They lie through their decimals.

What matters is the story...and our story now centers on the role of one man: Ben Bernanke. But the story that most people hear...and believe...is false. It is like GDP growth in the Bubble Era...it may sound right on the surface, but the real story is opposite to what is commonly believed.

Bernanke 'wrote the book' on avoiding deflation, 'tis true. But he doesn't really have a clue what he is doing. He didn't really avoid a Second Great Depression. There isn't really a genuine recovery underway. And the world is not becoming a better place as a result of Ben Bernanke's exertions.

Au contraire...he's making a natural mess into an unnatural one. He's turning a depression into a Great Depression. He's making a bad situation worse.

At least, that is OUR plotline. But we'll let the story tell itself...day by day...and see where it leads us. If we are wrong about the plot...we'll find out...

Bill Bonner
for The Daily Reckoning Australia

• Ben Bernanke is a Victim of the Trade
• Does Bernanke Really Not Understand His Fate?
• Ben Bernanke is No Hero
• Ben Bernanke “Respectfully Disagreed” With Angela Merkel
• No Evidence of Recovery as Unemployment Getting Worse

All this goes to show is how completely the people in charge of things in the United States have lost their minds. They seem to think this mass exercise in pretend will resurrect the great march to the Wal-Marts, to the new car showrooms, and the cul-de-sac model houses, reignite another round of furious sprawl-building, salad-shooter importing, and no-doc liar-lending, not to mention the pawning off of innovative, securitized stinking-carp debt paper onto credulous pension funds in foreign lands where due diligence has never been heard of, renew the leveraged buying-out of zippy-looking businesses by smoothies who have no idea how to run them (and no real intention of doing it, anyway), resuscitate the construction of additional strip malls, new office park "capacity" and Big Box "power centers," restart the trade in granite countertops and home theaters, and pack the turnstiles of Walt Disney world - all this while turning Afghanistan into a neighborhood that Beaver Cleaver would be proud to call home.

America loves the word "recovery" as only a catastrophically sick society can. "In recovery" is the new universal mantra of loser individuals and loser nations. Everybody in the USA is in recovery. Even Michael Jackson (he may have given up on somatic activity but, on the plus side, as the Rotarians love to say, he's quit using drugs for once and for all, and the magazines have stopped publishing photos of him taken after 1990, when he turned himself into something out of the Hammer Films catalog).

To sum it all up, the US economy is in recovery. Paul Krugman says that we'll soon realize that Gross Domestic Product (GDP) is growing. He actually said that on the Sunday TV chat circuit. Not to put too fine a point on it, but I would really like to know what you mean by that Paul? Do you mean that the Atlanta homebuilders are going to open up a new suburban frontier down in Twiggs County so that commuters can enjoy driving Chrysler Crossfires a hundred and sixty miles a day to new jobs as flash traders in the Peachtree Plaza? Do you mean that the Home Equity Fairy is going to wade into the sea of foreclosure and save twenty million mortgage holders currently sojourning in the fathomless depths with the anglerfish? Do you mean that all the bales of deliquescing, toxic "assets" hidden in the vaults of Citibank, JP Morgan, Bank of America, et al, (not to mention on the books of every pension fund in the USA, and not a few elsewhere) will magically turn into Little Debbie Snack Cakes on Labor Day weekend? Do you mean that American Express and Master Card are about to declare a jubilee on accounts in default everywhere? Do you mean that General Motors will produce a car that a.) anyone really wants to buy and b.) that the company can sell at a profit? Are you saying we get a do-over, going back to, say, 1981? Did we win some cosmic lottery that hasn't been announced yet? What's growing in this country besides unemployment, bankruptcy, repossession, liquidation, gun ownership, and suicidal despair? In short, are you out of your mind, Paul Krugman?

The key to the current madness, of course, is this expectation, this wish, really, that all the rackets, games, dodges, scams, and workarounds that American banking, business, and government devised over the past thirty years - to cover up the dismal fact that we produce so little of real value- these days - will just magically return to full throttle, like a machine that has spent a few weeks in the repair shop.

This is not going to happen, of course. It is permanently and irredeemably broken - this Rube Goldberg contraption of swindles all based on the idea that it's possible to get something for nothing. And more to the point, we're really doing nothing to reconstruct our economy along lines that are consistent with the realities of energy, geopolitics, or resource scarcity. So far, our notions about a "green" economy amount to little more than blowing green smoke up our collective behind. We think we're going to build "green" skyscrapers! We're too dumb to see what a contradiction in terms this is. The architects are completely uninterested in the one thing that really is "green" - traditional urban design - and most particularly the walkable neighborhood. That's just too conventional, not special enough, lacking in star power, not enough of a statement, boring, tedious, so not cutting edge! We blather about high-speed rail, but you can't even get from Cleveland to Cincinnati on a regular train - and what's more amazing, nobody is really interested in making this happen. All we really care about is finding some miracle method to keep all the cars running.

What we've been seeing is nothing more than a massive pump-and-dump operation in the stock markets, most of it executed by programmed robot traders, with the trading nut provided by taxpayers current and future. These shenanigans add up to new risks and fragilities so extreme that the next time a grain of sand catches in the exquisite machinery they will sink the USA as a viable enterprise. We will end up discrediting not just capitalism, but also the idea of capital per se, that is, of deployable acquired wealth. As this occurs, of course, events on the ground will give new meaning to the term "reality television."

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Gone Fishin’ Investment Strategy
• A Recovery of Some Kind in Global Trade
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• Reader Mail: Manufacturing is Not a Dirty Word

But first, we apologise for being away the last few days, although we can see our shoes have been ably filled by Money Morning editor Kris Sayce. Some sort of tonsil/throat virus has been making the rounds here at the Old Hat Factory. It's nothing a course of antibiotics can't wipe out...in addition to wiping out all the natural bacteria in your digestive tract.

However we feel cleansed. All the toxins in the system have been sent packing. From here, the road to recovery begins with yogurt. Maybe we'll send a note to Fed Chairman Ben Bernanke, who has been nominated for second four-year term by U.S. President Barack Obama.

Why is the biggest story of the day? Because Ben Bernanke is a well-intentioned arsonist. Bernanke inherited an American and global economy built on an upside down pyramid of debt, with a very small asset base. When the entire edifice began to collapse in 2007, the Fed Chairman was slow to react.

But by the end of 2008, the Fed had expanded its balance sheet to over $2 trillion. It accepted toxic collateral from banks in exchange for U.S. Treasury bonds and notes. It set up new liquidity and credit facilities to keep over-leveraged financial firms afloat. And it began monetising mortgage and Treasury debt by creating new Fed money to support the U.S. housing market and the criminally reckless spending policies of the U.S. government.

Everything else in the financial markets flows, in one way or another, from the Fed's actions. Commodities first inflated, then deflated, and are now slowly inflating again as the U.S. dollar is systematically weakened by the Fed's actions. Investors are forced to speculate as well.

If there's one good result from the Fed's campaign to save housing by destroying the dollar, it's that investors have begun to realistically evaluate their alternatives outside the greenback and dollar-denominated assets. Emerging markets? Maybe. Energy? Probably. Precious metals? Definitely.

What about commercial property or retail stocks? Probably not. Scratch that. Definitely not!

Property group and retailer Westfield announced a $708 million net loss for the first six months of the calendar year. The good news is that met expectations by analysts. The bad news is that it doesn't really matter what analysts expect: that's a $708 million net loss.

If Westfield were married to America, it would ask for a divorce. Nearly one third of its revenue comes from its 55 U.S. shopping malls. But the company said sales per square foot at its U.S. properties fell by 6.2% from the same time last year. Conversely, sales at its Aussie properties were up 5.1%.

The company also took a $2.9 billion write down on asset valuations. Par for the course. Many of the assets purchased with debt at the height of the credit boom are deflating. It could have been an even larger write down, but the company booked a $932 million gain on financial instruments. We'll investigate just what those were and get back to you on it.

Retail is a terrible business to be in during a recession. Australia, backed by $50 billion energy deals and a committed faith in property, sports a lot of consumer confidence. That backs retail sales. But don't forget the primary economic and social trend right now: people are reducing their debts. They are cutting back, becoming more frugal, and learning to live within their means.

Of course, we think this is happening. But it could be totally wrong. Maybe the credit cards are finding their second wind and consumers are gearing up for one last credit bender. But our suspicion is that you are in the middle of a generational/cyclical shift in the attitudes toward debt and that this is generally bad news for retail stocks.

By the way, a few readers wrote in claiming your editor had it all wrong about Costco. Costco treats its employees well, sells at a fixed mark-up to its wholesale price, and operates on much different principles than, say Wal-Mart. Enough people wrote in that we thought we should mention this.

Fair enough. Our point wasn't to disparage the Costco brand. The main point was that massive retail outlets with bulk goods are only possible in a world with cheap energy and cheap labour. Maybe it's sustainable. But we have some serious doubts. Still, it looked like an awful lot of people queued up last weekend.

That's it for today. Good luck Ben Bernanke. "There's a lot of ruin in a nation," Adam Smith once quipped. Four years is not much time in the scheme of things. But the Fed can ruin a lot. Watch it try.

Dan Denning
for The Daily Reckoning Australia

• Giant Costco Opens in Melbourne!
• Zombies at the Fed and the Treasury Department Try to Gnaw on Survivors’ Savings
• A Bailout Bill for the Fed Should be Interesting
• 49 Million People Went Hungry at Some Point in 2008
• Oil Prices Fall 77%

I say this with such obvious disrespect because Mr. Krugman is on record has having advised the Bank of Japan to purposely cause inflation, as, "The way to make monetary policy effective is for the central bank to credibly promise to be irresponsible - to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs", although he never actually says where he is going to find guys stupid enough to loan money at negative interest rates, or in what bizarre alternate universe he lives where high inflation in consumer prices, particularly sustained high inflation, is anything other than a total disaster, which is why most of economics is concerned with the problem of preventing inflation while fostering growth!

In fact, he thinks that a central bank trying to reflate a collapsing economy should announce a deliberate plan to raise the level of prices (such as the Consumer Price Index) from current low levels to some dramatically higher value (a so-called "price-level gap") that it would have theoretically reached if a "moderate" and constant amount of inflation in prices had, in fact, occurred! Gaaahhhh!

To make it more Theater of the Absurd, he then says to keep creating more inflation in prices! Gaaahhhh! This is insane! This is beyond insane!

This would be bad enough coming from just another egghead academic dork from Princeton, but a terrifying quote from Ben Bernanke, chairman of the Federal Reserve, shows that he agrees with this with nonsense!

In fact, Bernanke said, "A successful effort to eliminate the price- level gap would proceed, roughly, in two stages. During the first stage, the inflation rate would exceed the long-term desired inflation rate, as the price-level gap was eliminated and the effects of previous deflation undone. Call this the reflationary phase of policy. Second, once the price-level target was reached, or nearly so, the objective for policy would become a conventional inflation target or a price- level target that increases over time at the average desired rate of inflation."

This is so dangerously preposterous that one's hands shake in fear and paranoia at the calamity that awaits a nation that takes such ridiculous advice, and there is nothing to be done except to buy more gold, silver and oil, as the last 4,500 years of history have proven that these are the things that have lasting value, unlike the bitter disappointment and dismay of paper money and "true love."

Obviously, people do not have to be around me very long before they learn that I am perpetually scared, to one degree or another, of inflation in prices, such as the other day, for example, when I had saved up enough money to have dinner alone at a restaurant so that I could eat one lousy meal without the wife and kids all the time whining and complaining about how they need more money, and want more money, and how they want me to give it to them, and how I am a terrible person for not giving them more money, how I am too stupid to get a better job to make more money and how I am too lazy to get a second job with which to earn more money.

So instead of having to listen to them talk about how much they hate me, I am enjoying the peaceful qualities of the restaurant when a guy seated at the next table sees me eating my steak and asks me how I liked it.

So I told him, "I like it fine, except I wanted lobster! Rich, flakey lobster to dip into real melted butter so wickedly delicious that you can actually hear your arteries hardening from just looking at it; but I can't order lobster because inflation in prices caused by the Federal Reserve creating so much money and credit all these years has resulted in the ugly news that they now charge too much for lobster, and inflation is so bad that some crappy, weak iced tea is almost two bucks a lousy glassful, most of which is ice!"

Out of the corner of my eye, I can see the other people in the restaurant have stopped eating and they are all looking at me. Figuring that they want me to further enlighten them, I go on, "So don't you ask to me about how I like my steak, when you should be asking me how I like inflation in prices, which I don't! Not one little bit! And if you weren't so stupid, you would realize that inflation in prices is the worst thing that can happen to us, and which is exactly what is going to happen to us because the damnable Federal Reserve is creating unbelievable, staggering amounts of money and credit so that the federal government can borrow and spend it in an orgy of deficit- spending that will end badly!"

Well, pretty soon the manager comes over and tries to censor the Heroic And Brave Mogambo (HABM) by telling me to shut up and sit down, although he might have been interested in the actual inflation figures, which are pretty bad!

For instance, producer price inflation shot up 1.8% in June, and it seems especially interesting that the Labor Department figures that the Consumer Price Index rose 0.7% in June, and although 0.7% does not seem like that much in one month, it adds up to a lot over the course of time; like for instance, in a year, when this 0.7% per month inflation compounds to 8.7% per year inflation! Yow!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• The Destruction of the Dollar by the Federal Reserve
• Central Bank Creates Excessive Amounts of Money to Expand Government Spending
• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
• Bad News if You Are Afraid of Inflation in Consumer Prices
• Everyone We Know Expects a Fairly Quick Up-move in Inflation