Like the two sides of the brain, people use politics both ways. On the right side, they use it to do something that is completely preposterous...and often completely at odds with their own interests.

Start a war, for example. National pride. Sentiment. Anger. Humiliation. There's no telling exactly what emotion will stir up the mob. And there's no telling what mischief it will get up to when it's been properly stirred and shaken. India was the site of the biggest political demonstration of all time. What was it about? Killing cattle. The Hindu population was against it...

Meanwhile, from Nigeria comes news that the Christians and Muslims are killing each other. And in Europe, just a century ago, people tried to kill each other for 4 long years...

But the right side of politics is beyond our scope for today. We're concerned with the left side...the rational...goal seeking...angle playing side...where people use politics like a burglar uses a crowbar - to get something that isn't theirs.

For example, a report in USA Today tells us that government employees have used politics to get more money. The paper said that 8 out of 10 professions are better paid by the government than by the private sector.

Lobbyists use the government to get money for their employers. If we read the item in The Wall Street Journal correctly, there were 10,000 "earmarks" in the latest budget bill.

What's an 'earmark?' It's a special little provision that gives a contract - or other favor - to a specific company, industry, or locality. A congressman might insert a little provision awarding a $100,000 contract, for example, to one of his constituent companies. Directly or indirectly, the company may have contributed $50,000 to the congressman's re-election campaign...or may be ready to hire him if he is booted out of office...or may have hired his son or daughter. The amount is so small that the rest of the Congress is not going to pay much attention to it. Besides, other members of Congress are doing the same thing. Ten thousand earmarks...that's more than 20 apiece.

Giving out money to friends and supporters is not exactly what Congress was set up to do. A Congressional Ethics panel was organized to investigate. Its report just came in this week. What did it find? That there was no impropriety; it was just business as usual!

Even the Ethics Committee has been corrupted by the left side of politics - the rational side. Everybody is looking out for Number One. Even the Ethics Committee.

Very predictable. And no harm in that. Everyone does it.

But as the political system matures, it supports more and more people who are looking out for Numero Uno and don't much care what happens to Numero Duo. And as the host weakens, the parasites become bolder.

Even the right side of politics is corrupted. Instead of going to war for purely absurd reasons, lobbyists for pentagon contractors urge the nation to war for practical ones...specifically, to add to their own profits...and generally to boost employment.

Eventually, between the left side and the right side, the nation runs out of juice. Or worse. When the politicians have squeezed all they can out of existing taxpayers they go to work on those who aren't even born yet. The debt rises and rises...until it is too heavy to carry. Then, all Hell breaks loose.

A few days ago, the Congressional Budget Office reported that the Obama administration's deficit forecasts were a little on the low side - $1.2 trillion short over the next 10 years.

How reliable are those CBO forecasts? Not very... The deficits are likely to be a lot higher than either the administration or the CBO now imagine.

Stay tuned...

Bill Bonner
for The Daily Reckoning Australia

• Paul Ryan and His Roadmap for America’s Future
• Underwater Homeowners Continue Making Mortgage Payments
• Looking at WPL and Oil Side by Side
• Feds are Getting Plenty of Taxpayer Support
• Politics and Investment Intertwined

European investors still have their eyes on Greece...a welcome diversion from their own sins and errors. More on this later in the week...

Asian investors still have their eyes on China. The powers-that-be in the Middle Kingdom seem to have begun tightening credit... If it continues, China's bubble will burst... Perhaps the most remarkable thing about this is that no one seems to know who the powers-that-be are. Ben Bernanke may be a fool. At least he's predictable. China's real leaders are unknown...and unpredictable. More on that sometime in the future too...

But for today...let's focus on the good news. Well, our first item is good news if you were fool enough to follow our "Trade of the Decade."

We suggested that buying Japanese stocks could be the best investment you can make in the next 10 years. We immediately heard from dozens of friends and enemies. The friends were concerned because they thought we'd made a bad bet. Enemies were delighted that we'd lost our grip completely. After all, they remarked, who in his right mind would buy Japanese stocks?

Well hardee, har, har... Guess what market is leading the world so far this year? That's right... Japan. Later, colleague Alex Green explains why Japan hasn't been such a bad bet after all.

We're six weeks into the new decade, we'll claim victory now...and change the subject. Who knows what will happen in the next 514 weeks.

Meanwhile, here comes more good news: the US federal government may not go broke after all. Rep. Paul Ryan, who hails from the sovereign state of Wisconsin, has come up with a solution.

Before we get to the solution, however, let us take a minute to describe the problem. In short, the feds are spending too much money they don't have. The Obama administration says it doesn't see any balanced budgets anywhere in America's future. The Congressional Budget Office, a far-sighted group if ever there was one, looks all the way to 2080. It sees no hint of fiscal equilibrium either. Just deficits and debt. By its estimate the US budget grows to 50% of GDP and the official US debt rises to 7 times GDP.

This exercise by the CBO is not a forecast. It is merely an extrapolation. If present trends continue, that is where we would end up by the time your author is 131 years old. Of course, there is no way present trends could continue that long. Even at 2 times GDP...debt cannot be sustained. It would cost more than half of all America's tax revenues to the pay the interest on such a large debt. Already, depending on how things go in the economy, as much as 30% of the money borrowed by the US could soon be necessary just to pay the cost of past borrowing.

Fortunately, Mr. Ryan has a solution. He calls it a "Roadmap for America's Future." After studying it for all of 30 seconds, we're convinced that Mr. Ryan should get a GPS. His roadmap is a series of squiggles, dodges and twists to US tax laws...along with a few torques to the spending side too... that leads the country to a dead end. Most of his effort has been concentrated on bringing health care outlays under control. No effort is made, on the other hand, to cut military spending. Typical. Weak, limp, pusillanimous. The benefits now; the costs later. That's why America's residual respect for Congress is just about exhausted. The institution is incapable of correcting its own mistakes. Instead, it just makes them worse. Even with Mr. Ryan's roadmap, America drives in the wrong direction for the next half a century. It is only sometime after 2050 that the federal budget deficits finally stop.

Any solution that doesn't pay off until we're all dead is no solution at all. It's a way of avoiding a solution...which is what Congress desperately wants to do. A real solution will come. But not from Congress. Instead, it will come unbidden. And unwelcome. Like the plague.

At least, that's our reading of history. Once the system tips out of control it stays out of control until it finally blows itself up.

It would be fairly easy to get the budget under control...that is, if there were no political system to prevent you. The US government shouldn't be in the business of giving out drugs or regulating heart transplants. It also shouldn't be in the business of telling the rest of the world what to do. The solution is simple: abandon the imperial agenda...let people take care of themselves, both at home and abroad...and downsize the federal government.

But that is not going to happen. We may be on the road to ruin...but too many people are enjoying the ride. We're not going to stop any time soon. More than 40 million people on food stamps...thousands of military contractors...millions of government employees... People who want the government (other citizens) to pay for their gall bladder operations. People who pay no taxes. GM executives. AIG bondholders. University administrators. Lobbyists.

It is a wholly rational and completely foreseeable trend. People always seek to improve their wealth and status in the easiest way possible. What's the easiest way? Take wealth from someone else. That's why criminals are still in business...after thousands of years of trying to stop them.

But common criminals lack status - except in the ghetto. So, the smarter, better connected and better educated of their ilk go into government. Or they use government for their own ends. That way, they get other peoples' money. But they also get respectability...even an elevated social status.

Congress is supposed to confront the problems of the nation...and solve them. But with more people getting something from the government than supporting it, Congress is not likely to change course. It responds to the perverse will of the people...and to its own corrupt predilections. We are all victims of democracy now...

The government grows...deficits become unstoppable...and the empire sinks under the weight of so many parasites.

Bill Bonner
for The Daily Reckoning Australia

• Dealing with Future Economic Problems Today
• The US Federal Budget
• Geithner and His Toxic Asset Bailout Plan
• Cleaning Up America’s Fiscal Policy
• How Does an Economy Expand When the Banks are Lending Less Money?

Last week, stocks went up. Stocks went down. Not much was proved one way or another. The week ended in a draw, as near as we can tell.

But we think we are making progress in understanding what is going on. The private sector is de-leveraging. Now, it's the public sector doing the heavy lifting. It is leveraging everything it can.

Leverage in the private sector led to the banking crisis/bear market of 2007-2009. Debt always leads to trouble. Next up: a crisis in the public sector.

But wait...hold on...not so fast...we haven't reached the end of the private sector crisis yet! Bank lending is still falling. House prices are still falling. Unemployment is still falling. Soon, stock prices will be falling again too...

First, let's see what's in the headlines. Last week there was a lot of press about the pay czar and his efforts to limit compensation in the companies that the feds bailed out. The public and the news media love this sort of thing. It's a battle between the greedy rich and the public interest, or so they believe. The public hates bankers. But they don't want to see just pay capping; they want to see knee-capping. We'd like to see it too. Or maybe public flogging. Or at least a lapidation or two.

But our true sympathies are with the greedy CEOs. After all, they stole the money fair and square. They should be allowed to keep it. The feds wanted to leverage up the financial sector by giving money to the banks. What'd they expect? The bankers took it.

Yes, the financiers are paid outrageous amounts of money - far beyond anything they are worth. In fact, if you studied it carefully, you'd probably discover that their net contribution to the betterment of mankind is now negative.

The bankers are betting that the money they were given by the feds will be worth less next year than it is this year. So they exchange it for everything and anything, confident that when it comes time to pay it back it will be even easier to come by than it is now.

So far the bet has gone their way. Copper has doubled. Gold is up 20%. Stocks markets all over the world are up 60%. Foreign currencies, too, have beaten the dollar.

Will the wager against the dollar continue to pay off? Well, that's the big question. If so, you should stay in stocks, gold and commodities. If not, you should move to cash.

But it hardly matters to the gamblers. They're playing with someone else's money! If the bets go well, they pay themselves huge bonuses. If they go badly...well...hey...gimme a bailout!

In the long run, bets against the dollar are almost sure to turn out okay. All paper currencies go to zero, eventually. But in the short run, who knows? The whole world is betting against the greenback. With such a massive short position against the buck, it would be just like Mr. Market - aka Mr. Mischief- maker -- to send the dollar up.

But you can't blame the bankers. They're performing a very valuable service. They are helping to separate fools from their money. Too bad we taxpayers are the fools....

Among all the whiners and kvetchers about bankers' huge bonuses hardly a single one draws the obvious conclusion:

That them that deserve to go bust should be allowed to do so.

"I remain of the view," writes Martin Wolf, a bit pompously, in The Financial Times, "that the only thing worse than rescuing the system would have been not rescuing it."

He's welcome to his opinions. And if he used his own money to bail out the bankers we would have no objection. In that case, it would just be a futile and foolish act. Instead, he insists upon using our money...which raises the charge from stupidity to larceny.

Another message that came through last week was that the real economy is not improving. Good news came in from several quarters. But the news that really counts - housing prices and jobs - was bad.

"It's all bad. That's all we know," said John Stepek, editor of MoneyWeek. "People ask if we're going to have inflation or deflation. The bulls think we're going to have inflation. The bears bet on deflation. But I'm not sure it matters. We're probably going to have both.

"The point is, whichever we have, it's going to be the bad sort. Neither inflation nor deflation is necessarily bad. Prices have to adjust. That's how the market conveys its signals. When prices rise, it tells producers to get busy and increase output. When prices fall, it tells them to lay off. In the natural order of things prices usually fall. Or, they should fall. This is 'good' deflation. It just means that producers are becoming more efficient, as they should. There's good inflation too - when prices rise due to increased real demand. When people earn more money, they can buy more things; prices rise.

"But what we're going to see is bad. Bad inflation. And bad deflation. It is the result of monetary problems and mismanagement. And it is going to send all the wrong signals and inevitably make things worse. First, the deflation is bad because it is result of a massive de- leveraging accompanied by a write-down of debt and assets. It's a depression. Or a major recession. Or a 'great contraction.' Call it what you will. It's a deflation in which prices fall...and it's not going to be any fun.

"Then, there's most likely going to be bad inflation too - caused by the central banks printing too much money. This is bad inflation because it is just an increase in the quantity of paper money, not an increase in real demand.

"We don't know exactly what is coming. But whatever it is, it will be bad."

Another big item in last week's financial press was the "Cash for Houses" scheme. The feds give new house buyers an $8,000 tax credit. But since not all new buyers buy because of the credit, the actual cost to the government per additional new house purchased is much higher than 8 grand. For each additional house purchased because the credit taxpayers are paying as much as a quarter of the entire cost of the house.

And now there is a proposal to extend and broaden the credit. Soon it may be "Cash for Everything."

This sounds crazy, but there are a lot of economists who think more stimulus is necessary. Nobel prize winner Paul Krugman, for example. And Richard Koo, mentioned here last week. They've seen what happened in Japan. And they see that the real economy is not recovering as they hoped it would. Now, they warn that America might have a "Lost Decade" if it doesn't continue to stimulate the economy.

How long must it continue bailing out and stimulating? Until consumers have finished de-leveraging, they say. How long will that take? Maybe another 5 years, by our calculation...maybe much longer.

But wait...the whole problem is too much debt, right?

Yep.

But the only way the government can stimulate is by going further into debt, right?

Yep.

And isn't the budget deficit already at $1.6 trillion...or 11% of GDP...the most it has been since WWII?

Yep.

Well, then where's the benefit? Won't the public sector have to de- leverage too?

Bingo!

How does the public sector deleverage?

Two possible ways - honestly...and dishonestly. It can pay down its debts to a level at which they can be carried even if interest rates go up sharply. They did it after the War Between the States...after WWII...and even during the Clinton years. Believe it or not, when the Congressional Budget Office looked ahead in 2001, it saw a budget SURPLUS for 2008 of more than $600 billion. Surpluses had been coming in for years during the Clinton administration. They thought it would keep going like that. Instead, 2008 saw a DEFICIT of nearly $500 billion.

The higher the debt and deficits go the harder it is to pay them down honestly. Eventually, the feds reach the point of no return...like a guy who's so deep in debt he can't possibly work his way out. Then, you get another crisis...either in the form of default...or (hyper) inflation...or both.

Tomorrow, we're off on the road to the Andean highlands...

No phone. No internet. No fax. No Blackberry. No iPhone.

We've got cows to round-up, wrestle, and vaccinate.

In the meantime, we'll leave our "Crash Alert" flag flying...and send a message as soon as we can...

Until then,

Bill Bonner
for The Daily Reckoning Australia

• Bankers Take Money From the Government and Use it to Speculate
• The More Money in a Financial System the Less Each Unit is Worth
• Warren Buffett: People Do Not Make Money by Betting Against the US Economy
• Japanese Government Displays Generosity as Prices Fall in Japan
• The Feds Are Trying to Avoid Deflation

Hey, why not! They had such great success with the Clunker tax credit...and with the first time house buyer tax credit. Of course, when you pay people to do things, you can't be too surprised that they do them. And then, you can't be too surprised when they stop doing them after you stop paying them. Thus, when the Clunkers program conked out in August car buyers stopped buying. And when the new house purchase tax credit expires in November, don't be surprised if house sales collapse too. So, if the feds are going to pay people to hire other people, they better be prepared to do it for a long time.

Which brings us back to our calculations. How long will it be before this economy can walk without the feds clutching both arms? A few months ago, we wondered how long it would take consumers to put their finances back in order. Five years? Ten years? There are so many assumptions required that the numbers barely make sense. Still, if you think the total debt burden is headed back to under 200% of GDP, where it was for most of the last century, that would require the elimination of debt equal to about 160% of GDP...or more than $20 trillion worth. How do you eliminate debt? Well, some of it simply disappears...through defaults, foreclosures and bankruptcies. The rest is paid off. How? By saving. Now, imagine that the United States could put an amount equal to 15% of GDP to work paying down its debts. That's savings and capital formation of all types - corporate as well as individual. It ignores government, which is going in the other direction. At 15% of GDP per year, paying America's private debt down to under 2 times annual output is still about a 7-year project.

So, prepare for a long dry spell. In the best of cases, the American public has to stay on the frugality wagon for 7 to 13 years.

And in the worst of cases? Oh, well...that's a different matter. The aforementioned US government is desperate to short-circuit the process of balance sheet repair. It is propping up the old tree every way it can. Thus, the whole period of adjustment may take much, much longer than it should. Instead of coming down with a crash, the limbs fall off one at a time. At this rate, the whole process could take nearly forever.

As the private sector eliminates debt, for example, the feds add it. The deficits are scheduled - by the Congressional Budget Office - to be monstrous, but controllable. Cash for clunkers, cash for houses, cash for jobs - it adds up. But the CBO projections are based on very optimistic assumptions, in which the economy 'recovers' quickly and grows strongly. They do not take into account the real nature of the slump. It is not a pause...it is a permanent change. The Obama administration cannot, ultimately, prevent change. But it can slow down the process so much that the depression begins to seem eternal.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Barack Obama is a Strong Favourite to Win the Presidency
• Cash for Clunkers Cars
• Obama Urged to Fix Airline Industry
• The Economy, Too Much for Obama?
• Economists Agreed the Stimulus Was Working and the Recession Was Coming to an End

This afternoon, we have been invited for a private tour of a grotto not far away. According to our information, hundreds of years ago, the grotto was sealed off by falling rock. Thus it was protected and preserved remains of human habitation from 30,000 years ago.

"Yes, there is a span of about 10,000 years in which there is little evidence of human habitation in Europe," said the owner. "Maybe humans almost died out during that period; we don't know what happened. But when this cave was opened, we found some remains that were dated from that era. It's a remarkable find. A group of 20 scientists has been working there all summer. They told me they found 1,000 artifacts a day. Of course, we're not talking about statues and battle axes. Most of these discoveries are bone fragments...maybe even grains of cereal..."

We'll find out more this afternoon...

Meanwhile, we turn our attention to the world of money. And we begin by asking:

Just what are we trying to figure out?

Well, we want to understand what is going on...don't we?

And we want to try to guess about what is likely to happen next, don't we?

We'd like to know, for example, whether stocks were going up or down...and whether this is a good time to buy property...or gold...or Treasury bonds. We'd like to know, wouldn't we?

Of course we would. Unfortunately, 'it is not given to man to know his fate,' as the ancients put it. All we know is what happened in the past...and the fate of men who came before us... Even that we known only in a wispy, uncertain kind way. All we have are stories...

Back to that in a moment...

Here are the facts from yesterday:

The Dow rose 30 points. Oil closed down - to $72. Gold remained where it was.

Ben Bernanke was put up for another term as head of the Federal Reserve. And the Obama administration said the downturn was a little worse than it had thought, so it's estimate for the 2010 budget deficit had to be updated - increased by 19% - to $1.5 trillion. The Congressional Budget Office did its own count and came up with $1.4 trillion. Either way, it's a lot of money.

We have wondered where the money would come from. Yesterday, Goldman's top economist, Jan Hatzius, said he thought much of it would be 'monetized' by the Fed...with the Fed's balance sheet increasing as much as $2 trillion.

The Fed's balance sheet is the monetary ballast for the whole economy. As it increases, so does the amount of sail the economy can put up. In theory, the potential for inflation increases geometrically; one dollar on the Fed's balance sheet could be multiplied into $10 in the economy. Bernanke has already doubled the Fed's balance sheet - buying up and additional $1 trillion worth of Wall Street's failures and the feds' debt. He might have to buy another $2 trillion worth - bringing the total to $4 trillion - before this crisis is behind us, said the Goldman fellow.

Home prices are still going down, says the latest report, but 'less than forecast.' Is that good news? Well, it could be worse.

The latest sales figures show an uptick. But careful analysis shows that homes sales figures are still terrible. People are buying $250,000 houses...but they're the houses that sold for $500,000 in 2005. And the poor folks with $500,000 houses...and jumbo mortgages...are sinking. Almost half of them will be underwater by 2011, according to one estimate.

The feds now say that 10% unemployment is unavoidable. Naturally, when people lose their jobs they have a hard time keeping up with mortgage payments.

"Bay Area Delinquency Rates Soar," says a headline.

Two years ago, when a homeowner was late on his mortgage payments, there was a 45% chance that he'd catch up. This is known as the "cure rate." Well, now the cure rate is down to 6.6%. Homeowners never catch up...they fall further and further behind until the house is foreclosed.

Want some more news? In past recessions, the United States emerged first and pulled the rest of the world out of its funk. This time, the United States is still on its way down...so analysts look to China. The Peoples' Republic says it is growing fast. It also says it will have an inflation rate of 2% this year. Currently, prices are falling at a 1.8% rate. China is in deflation, not inflation. What's up in China? We won't know for a while...but don't count on it to pull the world out of a correction. China needs a correction as much as anyone.

We've been alerting readers to a special announcement that Strategic Short Report's Dan Amoss was set to make this past Monday: the next major bank headed for collapse.

Not only did this report create a major buzz at the Agora Financial headquarters in Baltimore, but on Monday, national media outlets began digging around for more details on Dan's financial short play.

Out of respect for those who took us up on the Strategic Short Report offer, we aren't going to release the name of the bank - yet. But we can tell you this: this bank not only didn't reduce their dividend, they dropped their loan provisions.

Day traders may be cheering, but for the long haul, this spells disaster. Says Dan: "I still expect a big surge in provision expenses, likely as soon as the quarter ending in October. If you don't believe that the Canadian and US economies are going to come roaring back, which I don't, this is still an attractive short sale."

For 40,000 years - maybe longer - our ancestors have walked the very earth where your editor puts his feet. They lived. They died. What did they know? Scientists say they were as smart as we are. What did they talk about? What did they think about?

"Every time something is given, something is taken away," we suggested over dinner last night.

"No, that's not right. You're saying that life is a zero-sum game...that it can never get better...that it can never really improve...that there can be no real progress..." Elizabeth replied.

"Well, not exactly...I'm saying that there are no free lunches in nature. That if a man is smarter, he is not likely to be faster too. But I'm not saying anything particular...or scientific...I'm just announcing a general principle...more like a vague intuition about the way things work. According to one theory, for example, mankind migrated from Africa to Europe. In Europe, during the Ice Age, he encountered a great challenge: cold weather. Most humans and pre-humans probably couldn't survive it. But some did. And they did by evolving into maybe smarter...maybe slower...people with bigger heads. According to the latest thinking on the subject, the bigger brains were a disadvantage in warmer climates...because they got too hot. I guess they took up too much energy too.

"But they were an evolutionary necessity in colder climates...where the cold weather not only made possible a hotter head, but also made it a necessity. People needed bigger brains to anticipate the change of seasons and save winter, for example. They had to see what was coming. They had to look at what was coming...and prepare for it. They had to work together too...to hunt large game...and to fight off competitors. Those who couldn't do so died out. Well...that's the theory."

Every day, here at The Daily Reckoning, we give you information on the latest trends and events in financial markets. But everybody has access to the same information. And what is information, anyway? What is it worth? What does it mean?

For thousands of years, people exchanged information. Then, it must have been a different kind of information...things we can barely imagine...about where animals were getting their water...about where to find seeds and how to avoid sickness...how to prepare for winter...and how to fend off wild animals. Then, the dominion of the human species was not so sure. There were saber-toothed tigers, lions, wolves, even mastodons...giant sloths... Early man was probably as often prey as hunter. He had to be on his toes to survive.

Information was one thing. But there was more. He needed wisdom...and technology... as well as facts. He had to learn to store food for winter as well as beat back attacks by wild beasts. He had to know how to make cloaks out of animal skins...and how to stock firewood for a rainy, snowy winter...and how to find shelter.

We imagine tribes sat around the campfire and told stories. The stories reported victories and defeats...disasters and triumphs...heroes and enemies. But the stories were more than just information: they carried lessons...moral lessons...about what to do and what not to do.

That is the tradition to which we are heirs here at The Daily Reckoning. We pass along information: but without a story, the information is just noise.

Our story is the story of the seasons. It's the story of heroes and villains...of fatal flaws and inevitable disasters.

The common flaw is an old one. The Greeks couldn't seem to tell a story without mentioning it. 'Hubris'...the kind of pride that goeth before a fall...the arrogance that leads people to think they can get away with something... that they not only can know their fates...but that they can control them.

Today, Ben Bernanke is our tragic hero. His flaw is as obvious as his challenge. He thinks he can stop the world from turning.... stop the seasons...avoid the hard, correcting winter by tempting the sun with bailouts, stimulus and cheap credit. His arrogance is an affront to the gods.

The old tales tell us what will happen. He will fail. But when...how? That is a different story. It is the story future generations must tell. We must live it.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Oil Prices Decline but Consumers Aren’t Out of the Woods Yet
• The Challenge of a Balance Sheet Recession
• Dollar Declines as Gold Rises
• Gold ETFs Aren’t Looking as Good as They Used to Be
• What Kind of Investor is Happy to Lose Money Over 90 Days?

First, let's look at what those penny pinchers in the federal government are up to. The Congressional Budget Office (CBO) recently released its analysis of the Obama Administration's ten-year budget proposal. The projected deficit for (fiscal year) 2009 is a whopping $1.8 trillion. Now the president has said, in effect, that you need to spend money to save money, but the CBO projects deficits once again exceeding $1 trillion by 2018. In fact, over the whole CBO forecast from 2009-2019, the lowest the deficit ever goes is $658 billion.

This should be rather surprising to anyone who actually took Obama at his word when he promised to restore fiscal discipline to Washington. In fact, the CBO projects that the outstanding federal debt held by the public will increase from 40.8% of GDP in 2008 to 82.4% in 2019. In other words, the CBO predicts a doubling of the national debt in a mere decade.

One last thing to give you chills (and not the good kind): The CBO is not exactly a doom-and-gloom forecasting service. They're run by the government, for crying out loud. This is the same CBO that projected at the start of the Bush Administration ten years of an accumulated $5.6 trillion in budget surpluses.

I would caution readers not to dismiss all CBO numbers as obviously meaningless. On the contrary, I think we will see the same pattern play out under Obama as under Bush: Because the CBO in both cases is grossly overstating future tax receipts, its projections for the Obama proposal are going to turn out just as rosy as they did back in 2001. Besides anemic tax receipts, if mortgage defaults continue to increase, the CBO projections on losses from the Treasury's numerous "rescue" measures will also be far too optimistic.

In short, I think we should view the doubling of the national debt (as a share of the overall economy) over the next decade as a naïve best- case scenario.

If fiscal policy is a disaster, monetary policy is even worse. Unfortunately, the issues here get very complicated, and so it's difficult for the layman to know whom to trust. Not only do left- wingers like Paul Krugman say that we need more inflation, but even (alleged) right-wingers like Greg Mankiw are saying the exact same thing. With all due respect, those guys are crazy.

Normally, I do my best unshaved-guy-wearing-a-sandwich-board routine by showing this Fed chart of the monetary base. But every time I do that, some wise guy argues that I don't understand how our banking system works, and that because of "deleveraging" we are actually experiencing a shrinking money supply.

No, we aren't. It's true that there are forces tending to shrink the money supply, but Bernanke has more than overwhelmed them. All of the standard measures of the money stock went way up during 2008, even though prices (as measured by the CPI) fell in some months. For example, the monetary aggregate M1 consists of very liquid items such as actual currency held by the public, and checking account deposits. It does not include the monetary base (which we know has exploded through the roof). Even so, look at the annual percentage graph of M1 recently; it's grown at almost a record rate:

Now the reason prices haven't exploded is that the demand to hold U.S. dollars has also increased dramatically. (That's also what happened in the 1980s: the Reagan tax cuts and Volcker's squelching of severe price inflation made it much more attractive to hold dollars, and so the Fed got away with printing a bunch even though the CPI didn't increase wildly.)

Once people get over the shock of the financial crisis, the new money Bernanke has pumped into the system will begin pushing up prices. Others have used this analogy before me, but it's still apt: The U.S. economy right now is like Wile E. Coyote right after he runs off a cliff but hasn't yet looked down. Once the spell of a "deflationary spiral" is broken by a full quarter of significant price hikes, there will be an avalanche as people come to their senses.

Some analysts concede that the traditional Fed policies have indeed left the dollar vulnerable to serious devaluation, but they think the central bank wizards can save the day by acquiring new "tools." For example, San Francisco Fed president Janet Yellen has been arguing that the Fed should be able to issue its own debt, to give the Fed more flexibility. The idea is that when the time comes for the Fed to sop up the excess reserves it has pumped into the banking system, it would be devastating to the incipient economic recovery if the Fed has to dump a bunch of mortgage-backed securities, or Treasury bonds, back onto the market. This would ruin the banks with MBS on their balance sheets, and/or it would push up interest rates for the government. Thus, the Fed would have painted itself into a corner, and it would have to choose between massive CPI hikes or a renewed recession. To avoid that nasty tradeoff, Yellen argues that if the Fed could sell its own debt, then it could drain reserves out of the banking system without unloading its own balance sheet.

For a different idea, economists Woodward and Hall think the Fed just needs the ability to charge banks for holding reserves. The Fed already (recently) obtained the right to pay interest on reserves, and so Woodward and Hall think the Fed should also have the ability to do the opposite, i.e. to be able to pay a negative interest rate on reserves that banks hold on deposit with the Fed.

How does this avert the threat of hyperinflation? Simple, according to Woodward and Hall. If banks ever start loaning out too much of their (now massive) excess reserves, and thereby start causing large price inflation, then the Fed can simply raise the interest rate it pays on reserves. Banks would then find it more profitable to lend to the Fed, as it were, rather than lending reserves out to homebuyers and other borrowers in the private sector. Voila! Problem solved.

Obviously these tricks can't avoid the consequences of Bernanke's mad money printing spree. At best, they would merely push back the day of reckoning, while ensuring that it grows exponentially (quite literally).

A quick numerical example: Let's say the Fed wants to drain $100 billion in reserves out of the banking system, in order to cool off rising prices. But it doesn't want to sell off some of its assets on its balance sheet (like "toxic" mortgage-backed securities), so instead the Fed sells $100 billion worth of the brand new "Fed bonds," as Yellen hopes.

In the beginning, this will indeed solve the problem. When people in the private sector buy the Fed-issued bonds, they write checks on their banks and ultimately those banks see their reserves go down at the Fed. There is less money held by the public, and so prices don't rise as quickly.

But what happens when the Fed bonds mature? For example, if the Fed sold a 12-month bond paying 1% interest, then after the year has passed our private sector buyers will hand over the securities and now their checking accounts will be credited with $101 billion. At that point, the economy would be in the same position as before, only worse: there would be an extra billion in newly created reserves (because of interest on the Fed debt).

The financial gurus running our financial system and advising our political leaders aren't even thinking two steps ahead when making their cockamamie recommendations. For those readers who share my skepticism, the solution seems clear: You need to transfer your wealth out of assets denominated in fixed streams of U.S. dollars, and switch to something that responds to large price inflation. In short, sell your corporate and government bonds, and start stocking up on precious metals.

Regards,

Robert Murphy
for The Daily Reckoning Australia

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As near as we can tell, the financial world conveniently remained on hold while we were gone. As of Sunday night, little had changed. Gold, stocks...economists...politicians - they're all about where we left them. That is to say, the bear market rally on Wall Street continued. The feds continued to pervert the economy with their bailouts. Economists continued to call a spade a petunia. And politicians and commentators continued to blab and bluster about nothing.

But yesterday, the rally on Wall Street got smacked in the chops. The Dow fell 289 points. Oil dropped to $45. Investors were selling stocks - mostly financials - and turning to the dollar and gold for safety. The dollar rose to $1.29 per euro. Gold returned to $887.

The most important fact still sits like an alien spaceship on the White House lawn - so monstrous and dumbfounding that people don't know what to make of it...so they simply ignore it. The U.S. government is spending $13 trillion - nearly an entire year's output - to 'fix' the problems caused by the worldwide financial meltdown. Of course, they can't actually fix anything. Companies that are losing money are still going to be losing money. Investors are still going to take losses on stocks and bonds that were overpriced. Bad debts are still bad. Bad investments are still bad. A kiss is still a kiss. A smile is still a smile. Time goes by just like it always did.

But this $13 trillion of extra spending is bound to have some big effect. What?

A Financial Times article, written by one of Obama's advisors, makes a guess:

"The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president's budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

"...the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases.

"But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now.

"The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit."

If that was a bit hard to follow, here is our friend, Ron Paul, with a more succinct explanation:

"When I talk to many teenagers, [and] grade schoolers, they seem to have no problem comprehending the fact that if you just create a lot of money, it'll be like monopoly money and it won't have value," he told the I.O.U.S.A. crew when they sat down with him for an interview for the film.

"Governments do that for all kinds of reasons, especially to enhance political power to fight wars we shouldn't be fighting or to be passing welfare programs that aren't deserved. When you print that money, the value of that dollar has to go down and then one of the consequences of inflating the money will be higher prices. But there are a lot of other problems with inflating, it causes financial bubbles and it causes a lot of economic distortions and unemployment - but inflation is very simple. When governments create new money out of thin air, you have inflation."

Inflation? When? How much?

No one can say.

Maybe not for a long time. But when it comes...it will take our breath away. That's why we urge you to protect yourself and your money while you can. Especially now, with just shy of $11 trillion in debt already piled up... another $8.5 trillion already committed to the bailouts... and $3.6 trillion more in new spending on the table.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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The current administration's economic strategy will create an unmitigated disaster - not only our country's worst financial calamity, but the greatest economic disaster in recorded history.

I first warned my readers about what was happening last December, in a letter titled The End of America:

"The coming great inflation will destroy America's economic leadership. It will lead - eventually - to the return of settling international obligations in gold instead of paper dollars. And this will happen much faster than anyone expects.

"By the time Obama leaves office, you will not be able to exchange dollars for any sound currency in the world without permission from the U.S. government. The price of gold will be well over $2,500 per ounce. Most importantly, commodities will no longer be priced in dollars either, but instead in the currencies of the leading producer. Americans haven't experienced anything like this since the Great Depression."

Since I wrote that first warning, I have become much more concerned and much more afraid. What the president has done is actually worse - much worse - than even the dire scenario I had envisioned. Not only is the administration planning on enormous deficit spending this year, but the current plan calls for increasing deficit spending for the next decade - spending that will more than double our entire national debt during his presidency.

The Congressional Budget Office produced the following graphic, which compares the deficits of the 1980s and 1990s to the current and future budgets. Assuming Obama remains in power over the next eight years and assuming these deficits aren't actually much larger (which almost always happens), the Congressional Budget office estimates the president's budget will add more than $10 trillion to the total federal debt by 2019 - approximately as much total debt as was outstanding at the beginning of 2007.

Obama plans to borrow more money over the next eight years than all of the other presidents - combined.

It's very hard to put this in perspective. The numbers have become so large they're almost meaningless. "Twenty trillion" has 13 zeros: $20,000,000,000,000. Nobody can think about a number that large. But consider this... In 1980, the entire federal debt totaled $930 million. Assuming we're paying 5% on our debt in 2019, we will spend more money on interest than our entire national debt of 1980.

This level of debt is going to be a huge problem because no one will want to pay the money back - ever. And it can't be financed forever. The poor will blame the rich. The rich will leave and take their wealth offshore. And absolute chaos will follow. The dollar will be completely destroyed.

Now... I know... you're thinking, "I've heard all of this before. But the end of the world somehow doesn't happen. We find a way out."

Not this time. In fact, when I wrote last year that the dollar would cease to be the world's reserve currency much faster than anyone expects, I'm sure no one took me seriously. But since then, we've heard two of the world's leading powers - China and Russia - both openly suggesting a new world reserve currency must be created. Putin is even talking about using gold to settle international trade. It will happen because no one will want to be a creditor to the United States.

As more and more people try to get out of the dollar, the government will be forced to forbid the free exchange of dollars into other currencies - and perhaps even to forbid the purchase of gold bullion. This will happen. I guarantee it. And it will happen during the Obama administration.

That's why it's critical for you to take precautions now, while you still can.

The first thing you should do, if you haven't yet, is buy gold bullion. It's easy: You just call a few coin dealers, find out who offers the lowest premium on bullion, and wire them the money. Once you have the coins, they're easy to hide, easy to store, and easy to transport. There's no law (yet) saying you can't take bullion out of the country. If things start moving that way, you should have enough time to get the bullion out before the law passes. If not... well... you can clip your coins easily and use the gold to pay for whatever you might need.

I also believe you should immediately buy gold stocks. In fact, I'm convinced you'll never have a chance to buy gold stocks this cheaply again... Gold stocks have never been cheaper compared to the price of gold itself. This is an amazing, once-in-a-lifetime opportunity. I truly hope you'll capitalize on it.

The second thing you should do is move as large a percentage of your financial assets as possible out of the country. Unfortunately, I don't know enough about this yet to offer any good advice. I'm working on it.

And the third thing you ought to do is to build a stimulus package for yourself. I realize it's paradoxical. But the coming crisis will make lots of people rich. It's not hard to generate a paper fortune in a huge inflation. All you have to do is own the most important economic assets: energy, communication, and transportation. Thing to do right now is buy the assets you know the government has to have for the economy to function. These assets will remain in private hands, and their values will increase the most.

I can tell you what happens to countries that go bankrupt. I've been to Argentina. I'm familiar with the history of Mexico and Great Britain. We'll see the same things here, shortly: inflation, huge tax increases, capital flight and, eventually, capital controls.

It will probably take decades for Americans to realize socialism doesn't work. But that clarity might not happen during my lifetime. And I don't want my assets to be stuck inside a banana republic in the midst of a huge socialist experiment. I'm graveyard serious: If you do not take precautions and prepare yourself and your family for the inevitable collapse of our currency, you will suffer incredibly over the next decade.

Good investing,

Porter Stansberry
for The Daily Reckoning Australia

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The state governments are reacting as you would expect, initiating all kinds of tiny spending cuts, massive stealth tax hikes, freezing of new hiring, new borrowings (which has now reached 7% of annual tax revenue in Florida), and the raiding of trust funds to "plug" budget gaps, which only get worse and worse now that the predictable economic catastrophe of boom-turning-to-bust has, at long last, started.

The St. Petersburg Times reports that Amy Baker, the chief economist for Florida's government, has discovered "a projected $3.5 billion hole in the state's budget" and has now "sounded a series of alarm bells" that have "added a new term to Florida's fiscal lexicon: a 'structural imbalance', the gap between the growth in the state's revenues and its larger ongoing expenses", which is, of course, wonderful news for those of us who desperately yearn for yet another term that means "A government spending more than it receives in the quest to give everyone a perpetual free lunch."

But you will be glad to know that Florida, like many states, is determined not to let that happen, as the whole problem is immediately rendered insignificant when, as Ms. Baker is later quoted as saying, "The budget's going to grow, independent of any revenue constraints."

At this, I laughed in a tentative, nervous way - "Hahaha" - at the prospect of Ms. Baker finding a way to let the state's budget grow forever, regardless of how much money comes in. Again, her words echoed in my brain; "The budget's going to grow, independent of any revenue constraints." I feel a cold chill.

Desperate for comic relief, I turn to the September 10 article in the Wall Street Journal titled "Budget Deficit Likely Doubled for Fiscal '08", mostly because I thought we WERE in fiscal 2008 already! Anyway, the new fiscal year begins on October 1, less than a month away, and the United States Congressional Budget Office's new calculation of the "budget deficit" is a terrible, and yet a laughable, $407 billion.

Another reason that I am amused by the Journal article is that with all the talk of a budget deficit, and previous budget deficits, and how calculating it is such a difficulty, blah blah blah...not once does the article mention the size of the damned budget that produced the deficit! Not once! Therefore, I laugh "Hahaha!" to indicate comic bemusement tinged with horror.

I assume, as I always assume since I am such a paranoid, suspicious and very creepy little weirdo that correctly sees government as "goons with badges and guns who are all out to get me", that the Journal is a co- conspirator with the government in down-playing anything that might upset anyone, such as revealing the gut-wrenching fact that the federal budget is now more than a staggering $3 trillion dollars, which is a hefty $10,000 for every man, woman and child in the country, and it's equivalent to $30,000 being spent by everybody who has a non-government job!

Later on, we learn that the 2007 U.S. budget deficit is reported as being $161 billion, which makes me laugh again in derision and scorn, "Hahaha!" as my initial reaction, of course, was to loudly heap scorn and ridicule on the Congressional Budget Office, because I happen to know that the national debt is $9,669.9 billion, whereas last year at this time it was $9,006.0, meaning that in the last 12 months, the national debt increased $663 billion.

So, for the Congressional Budget Office to bring up the totally irrelevant 2007 fiscal budget deficit of $161 billion makes me yell, "Off with his head! Off with his head!" with every bit of imperious Red Queen arrogance I can muster.

But the point is not that I look ridiculous dressed up as the Red Queen from Alice in Wonderland, or that everybody is lying their heads off about the U.S. government's spending deficits and ignoring the government's intellectual deficits, but that all of this deficit spending means that more money has to be created, which will create more inflation in prices, which means more money must be created, which means more inflation in prices, around and around, which is why everyone should be buying gold and silver, but nobody is, making themselves look ridiculous, and then they turn around and say that I look ridiculous in my wig and crown!

Ha! I say, "Off with their heads, severed with a golden sword!", which is so deliciously ironic that they should plotz from it, and even if they don't, I can get my revenge by getting stinking rich by buying gold and silver at these lows, courtesy of them not driving the prices up by buying them, too.

I hope revenge is as sweet as they say it is! Whee!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

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