"Much of the world is going through a downswing of the credit cycle. Argentina doesn't have and didn't have much credit. So it will be spared the big problems. But it sells farm produce to the rest of the world. It has to expect a period of sluggish sales and soft prices.

"I don't know if I would advise foreigners to bring their money to Argentina. But I would advise everyone to diversify beyond their home country - especially if they are American or British. Generally speaking, it appears that the go-go finance-based economies of the Anglo-Saxon world have peaked out. They lived on credit. Now, they die on credit. And they will find it very hard to shift their economies from credit-fueled consumption to investment-driven production and export. The competition is too stiff. America is a high cost producer. It can't compete easily with the developing and emerging economies. So, it will just have to get used to a lower standard of living. That means lower asset prices too. Which is why an investor - broadly speaking - can anticipate a higher rate of return from his investments in India, Brazil and even Argentina, over the next 20 years, than he can from the US."

But isn't Argentina full of crooks, booty-shaking tango dancers, escaped Nazis and Norteamericanos on the lam?

A friend of ours thought so. She was having lunch at a nice restaurant in La Recoleta, one of the nicest parts of town, when someone stole her purse. Poor thing, we were afraid her trip was ruined. But then, she got this email:

"Hi good afternoon, my name is Emiliano, is that i work doing maintenance of parks and squares in the area of palermo, and in one of the trash bins encontre a series of documentation to its name and among other things i could detect this mail.

"That is why i warn that i have the papers mentioned, licenses, passports, credit cards, etc. without more and in anticipation of any response on their side and wishing you are with their belongings, i leave my mobile Phone in order to combine a meeting so that you can restore their belongings, but more, i dismissal of you carefully."

She writes: "This 'Santo Emiliano' is now and always will be the patron saint of Buenos Aires. He has restored my faith in humanity by going beyond his job tidying up the beautiful local parks and helping a total stranger to once again see the real beauty of his city. He explained that he enlisted the help of many friends to compose the email above. I get teary-eyed thinking about it. I can't wait to meet him and try to explain to him in my broken 'castellano' that he is working in the wrong municipal department and should be promoted to the head of the department of tourism!

"Ah, the world is once again a nice place to live."

And lastly...

"I must say," Elizabeth began, after hanging up the phone. "Being married into your family is an enriching experience."

Elizabeth comes from a good New York family. Her ancestors were ambassadors, officers in Washington's army, heiresses and socialites. She went to private schools and then to an Ivy League university. Poor thing. She had never had much contact with Irish riff-raff, tobacco road farmers, and lowlife financial publishers. She can thank your editor for introducing her.

She had just been talking with one of our cousins. Well, the wife of a cousin who died suddenly last week. He was only in his 50s and seemed like a nice enough fellow. But he was no Harvard-trained go-getter.

"I felt so sorry for her [the widow]," Elizabeth continued. "Your cousin hadn't worked in years. He was on disability. I'm not sure what that is. Some sort of welfare, I guess. He didn't look disabled when we met him two years ago. He was such a big, strong man.

"But when he died, he left his wife with no source of income at all. She's applying for disability too. She has no income at all. I don't think they have any savings either. And her disability status hasn't been approved yet. It hasn't come through. I wanted to tell her that we'd help her but I felt a little awkward. I've only met them a few times. You should do something...

"There is a whole world out there that I didn't know anything about...that lives and thinks in a much different way than we did. They're very nice. I like all your family. But they have very different attitudes and habits than what I'm used to. I wonder what caused it. Maybe they probably worked hard when the steel mills were operating. But then, when the mills shut down, maybe they got in the habit of getting paid not to work. I don't know...but it's very strange."

"What do you mean," was our reply. "Your family didn't work for generations. They inherited wealth and spent it. They spent money they didn't earn. My family did the same thing. They just spent wealth from other families...and didn't get as much of it."

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Kirchners Lose Election in Argentina
• A Chilly Trip to Argentina
• Cattle Prices Have Risen Only 1% This Year
• Our Cattle in Argentina
• Painting the Shutters With the Family

Yesterday, it touched a new record - $1,050 - even as the dollar rose, oil slumped under $70 and stocks dipped very slightly.

Well, what do you expect? The United States added $1 trillion to its monetary base in the last year or so. The federal government is running a deficit of $1.7 trillion this year. And along comes Barack Obama with an idea to stimulate employment - spend more money! This time, Obama's plan is a kind of 'Cash for Workers' program...in which businesses get a tax credit for hiring new employees.

Gold investors must think the new program will be the straw they've been waiting for. Government has piled on bales of costly new initiatives on this poor camel's back. Still, he stands up straight.

So, is gold at $1000 a bargain...or a trap? Or both.

We begin by asking: where's the inflation? We don't see any inflation. What we do see is deflation.

Barclays Capital says gold could go to $1,500. We don't know where they got that number. It could go to $15,000 for all we know. Or it could go down, too.

Our guess is that it will go down enough scare the bejesus out of speculators. Then, it will soar.

But, hey, we're just guessing - along with everyone else.

Sooner or later gold is probably headed to the lunatic moon. We're sticking with the yellow metal. We don't want to miss that ride.

But when?

Ah...we're going to stick our necks out and say "eventually." We're sure we're right about this. Just don't ask us for more precision; we have none. And what bothers us is that between eventually and now there could be a lot of time and a lot of trouble. And one trouble that could come up pretty fast is another crash in the stock market.

If the stock markets of the world take another dive...like they did last year...gold will probably go down with them. Not as much, but down nonetheless. So, if we were speculating...we'd probably be short gold and short stocks too. We'd bet against bonds too - even though we think they will probably go up in the short run. The smart, long term money - in both stocks and bonds - is probably on the short side.

Here at The Daily Reckoning, however, we never speculate - except in print. As to ideas about how the world works we have plenty. We speculate daily. As to gold, stocks and commodities, we prefer to hold onto our long-term positions.

What seems fairly sure to us is that this recovery is a fraud. It's a mountebank and a flimflam.

And now approaches a moment of truth - earnings announcements. Stock market investors bid up shares on the theory that sales and profits would rise. Will they? We don't think so.

We think sales are going to be disappointing...and earnings will be even worse. If so, we'll see analysts begin to change their expectations...and announce that the results are "not as bad as expected."

If we get a few really bad announcements - with results much worse than expected - it could sink the rally. Then again, if we're surprised with exceptionally good reports...it could send the market in the other direction.

Good results will also cause us here at The Daily Reckoning to question our position. Maybe the economy is not sinking into a chronic depression, after all. Could we be wrong?

Ha ha...are you kidding, dear reader? Of course, we can be wrong. When we were younger we were uncertain about things. But now that we're older, we're not so sure.

Here is what we're pretty sure about:

1) The credit cycle has topped out.

Americans are saving - think of the poor boomers, 10 years older but not a penny richer than they were in 1999. Stocks have gone nowhere but down in real terms. Houses hit a high in 2006...now, they're off 30%...and still going down. Jobs? Forget it...there are already 15 million people who are unemployed and about 200,000 more every month. The job market is unlikely to recover for another 6-13 years - that is, after many of the boomers are retired! And if you are lucky enough to have a job, you're not likely to get a raise...not with so much spare capacity in the labor market.

Under those conditions, a consumer boom is very unlikely.

2) We know that a period of credit contraction is deflationary.

Prices go down as demand falls. Buyers disappear from the malls that once knew them, while the factories that produce stuff grow dusty and quiet.

But we know the feds hate falling prices. And we know they are taking extraordinary actions to get prices to go up. So far, their efforts have been a giant flop. Prices are falling in the United States at the fastest pace since the '50s.

Most of the feds' efforts have been directed towards keeping the bankers fat and happy...and getting themselves a bigger share of America's output. They took funds designed to relaunch the US economy, for example, and used them to buy themselves a big position in the auto industry, the financial industry and the insurance industry.

3) We know too, by the way they conducted themselves in those affairs, that the feds have become much more aggressive...throwing their weight around in the private sector as never before.

What we don't know is how this affects markets in the short term. So far, consumer prices are falling, but the stock market is enjoying a bounce. It is a real, new bull market? Or just a bear market bounce? It is probably a bear market bounce...but it has been going for long enough that we have to at least consider the idea that it is a genuine bull market. That's why the numbers from this quarter are important...they'll tell us if the companies themselves are expanding earnings fast enough to justify investors' optimism.

4) We know too that there is a whole lot of 'flation going on.

We are just unable to tell you what kind of 'flation it is. The monetary base is way up - it increased by $1 trillion in the last 12 months. But the money-in-circulation has barely budged. The feds give the banks overnight loans at practically zero interest. Then, the banks lend it back to the feds at nearly 4% more.

What happens to it then? Well, what do you think...it is wasted on typical federal government scams and humbugs.

So, relatively little of the money actually ends up in the consumer economy. And so, we can't tell you whether the 'flation will have a 'in' prefix or a 'de' prefix. They're just two letters. But they will make a whole alphabet of difference to the economy and to your investments.

5) Most important, we are dead sure that the people running America's financial policies are jackasses.

We say that with all due respect, which is probably not much. They have only one idea - and it is a bad one. They think economies are improved by more consumer spending. They don't seem to care why consumers occasionally cut back on their spending. All that matters to them is finding ways to get the consumer shopping again. So they try tax cuts and government spending...bailouts and boondoggles...zero interest lending and federal takeovers...cash for clunkers, cash for houses, cash for employees....

..trillions worth of claptrap and folderol. But what a nuisance! The fool consumer still won't shop!

But they're determined to keep trying. That's why we can be pretty sure that, eventually, they'll get inflation rates up. One way or another. And then, gold at $1000 will seem like an outrageous bargain.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Is Gold Going Up Because People Fear Inflation?
• Gold is More Like a Religion or a Political Position
• Feds’ Plan is to Reflate the Economy
• Markets Rise While the Economy Sinks
• The Economy is Getting Worse Not Better

..well, maybe not our souls...but at least our convictions.

But look at gold this morning!

Yesterday, we got word that the PPI rose 1.7% in August. Let's see, if producer prices are rising...consumer prices follow, right? Well...usually...

..but these are strange times...

We also got word that retail sales were up...that's UP...2.7% last month - the biggest increase in three years.

Now hold on. We've been saying that retail sales were going down. Not up. Our view of the big picture has a consumer in the center of it. And it's a consumer who is NOT increasing his spending. Instead, he's reluctant to buy anything.

There's a reason for that. He's a guy who didn't save anything over the last 10 years. Now, he's 10 years older...facing retirement with insufficient funds...and scared to death that he'll run out of money before he runs out of time.

The US consumer was counting on rising house prices to pay for his retirement. Now, he's disappointed...and worried. What can he do? He has to cut back. He has no choice. He can't depend on his house. He can't expect pay increases. Having neglected his savings during the fat years...he has to tighten up in the lean ones. He has to save at the worst possible time - in a downturn!

We don't see any way around this situation. We don't see any shortcut. We don't see any way to make it disappear or ignore it. THE CREDIT CYCLE HAS TURNED...from expansion to contraction.

Meanwhile, the feds are muddying the waters. They're trying to fool the consumer...to trick him...to make him think that up is down and down is up. They want him to believe that the fat years are coming back...that he doesn't have to save. In fact, they want to cause inflation...to encourage him to get rid of his money as soon as possible. That's why that PPI figure is important. If they can successfully inflate consumer prices (not just producer prices) the whole picture might change. Then, we'd have an inflationary depression rather than a deflationary one.

Our commodities man, Alan Knuckman, was on Bloomberg Television yesterday, talking about this very phenomenon. (You can watch the whole interview here.)

"What do you make of the PPI numbers?" the host asked him. "They did come in higher than expected. Is inflation going to be a concern for the market?"

"That is always a question," answered Alan. "The fed was trying to spark inflation and get money moving again. There is a delicate balance there, but we're coming off record lows and inflation numbers from last month. That is to be expected. I am not that concerned, but I think you are touching on something very important as far as the market momentum. If the market momentum is so strong right now - the one disconnect is crude oil. It is failing to make the highs, even though the market is. That is something to really pay close attention to I think."

For now, it appears to us that retail prices are still going down. And we doubt that the feds can cause a genuine recovery - simply by throwing money into the economy. You can boost spending when you're in a credit expansion...but not when you're in a credit contraction.

That's why we're suspicious of that retail-spending figure. How much of that is just spending funded and coaxed out by the feds? 60%? 80%? 100%?

David Rosenberg says it's 100%. He's probably right. And what would the economy look like without the phony demand ginned up by the feds? It would be shrinking at a 6% rate. And what will happen when the feds stop goosing it up? It will fall back.

But can't the feds continue stimulating the economy indefinitely? Maybe. Even so, the lesson we learned from the Japanese is that even with huge inputs from the government (the Japanese passed 11 separate stimulus measures totaling some $30 trillion yen) the real economy won't budge. Over nearly 20 years, the Japanese economy went from on- again, off-again recession to on-again, off-again deflation. The government muddied the waters. Still, consumers saw clearly what they needed to do. They had lost money in the crash of '90. Their Bubble Era stocks went down first. Then, their property went down too. They needed to save money for their retirements. This they did, resisting all of the government's efforts to get them to save.

Will the situation be any different in the United States?

Probably not.

Without extra earnings, the only way the consumer can increase his spending is by going further into debt. He is unwilling and unable to do that himself. The banks won't lend him money and he wouldn't take it if they would (at least, that's our view). So what's happening? The feds are borrowing big time - IN HIS NAME. They're running up federal debt - that he'll have to pay, one way or another. This money is then funneled to him in various devious and mostly ineffective ways...resulting in enough activity to make it look like something is happening in the economy.

It's a fake. It's a fraud. It's fundamentally counterproductive. But it's all it takes for people such as Ben Bernanke to believe the economy is recovering. Today's headline news:

"Bernanke says recession 'very likely' has ended."

And so, our convictions are put to the test. Everything seems to be improving. The numbers - many of them - show an increase in business and retail activity (New York's manufacturing index is at a 2-year high...).

The commentators, economists, and analysts all say things are getting better (except for those who know what they are talking about)...

And the stock market is still going up. The Dow finished up 56 points yesterday. Gold closed at $1006 yesterday. This morning, it's up to $1017. (More about gold later in the week...we've done a lot of drinking on the subject...) And oil is just under $71.

So, who's right? Who's wrong? Us? Or them? We say there is no real recovery going on...and there won't be one. They say the recovery is already here.

Stay tuned.

"You can still sell property," said brother Jim. "But only if you're willing to discount it."

Jim is visiting from Virginia. He is a real estate agent of some renown in Charlottesville, VA, dealing only with large farms and estates. His customers are on the golden side of the light spectrum; they tend to pay cash.

"Yes, these are not people who need to mortgage property. But the story is not very different. They still have their lives...and their problems.

"What's happening now is that there aren't many buyers and those who are buying expect to get very good deals. So, you can still sell a nice property, but only if you're willing to heavily discount it.

"Prices are down, say, 20-30% from where they were a few years ago. But the buyer wants another 30% discount. Not many sellers are willing to give up that much, so in my area there aren't many sales that go through.

"I'm lucky because I've been at it a long time. People know me. So when they want to move a property...or to buy one...they contact me. But I have to tell them what's going on. And I tell them that if they're not willing to sell at a big discount, it will be hard to sell at all.

"As I said, most people just sit tight. But a few get into situations where they don't have a choice. One poor woman has gotten sick. She is going into a nursing home and apparently the children need the money to pay her medical expenses...so they're forced to sell. Sometimes there's a divorce that forces a couple to sell a place. Otherwise, not much activity.

"And I feel sorry for all those real estate agents who came into the market over the last ten years. What do they do? There aren't enough transactions to keep them in business. But what else can they do? They're not a lot of jobs open in other areas either.

"My guess is that they are all treading water...hoping for a change...living off savings...until they have to make a big change."

We wonder how much of the economy is treading water...hoping for a lifeline...hoping that all this talk of 'recovery' is going to make it possible to avoid any unpleasant changes... hoping that things go back to the old normal...that somehow, everything will be all right again...

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Baby Boomers Face Early Retirement With No Money Saved
• What’s a Consumer Economy Need in Order to Keep Growing?
• Recession for the Japanese Economy Once Again
• Zero Percent Interest Rate Didn’t Work for the Japanese
• Lending Money Below the Inflation Rate

When we were in college we had no money. In the summer we had to work two jobs to try to save enough cash to continue. One summer, we worked in a boatyard in Annapolis early in the morning...then, we did an evening shift painting television towers. Painting the towers was such dangerous work our poor mother begged us to quit. But the money was good - $5.25 an hour - so we had to keep at it. More about that in a minute...

We've only got a minute before they call our flight, so we'll make this short. Nothing much happened in the markets on Friday...except that the price of gold rose $11. Gold seems ready for another attack on the $1,000 level. Will it get there? Maybe...maybe not.

Humility! Humility!

We have to remember that the world economy has never, ever been in a fix like this. We don't know where it will lead.

The big picture is that the credit cycle - expanding since the end of WWII - seems to be contracting.

"The joy of buying falls victim to recession," says a headline in today's International Herald Tribune. The article tells us how people are planting gardens again...saving money...making do.

This is likely to be a fundamental shift, not a transient one. But - humility! - what do we know?

What we suspect is that the upward trends of the last half a century have now reversed. We're in a period when the excesses and mistakes of the boom/bubble period must be corrected. A new model for the world economy must be found - because China can't continue to sell products to Americans if Americans can't continue to buy them.

But there's more to this big picture. Never before in history have so many government officials been so sure they could stop a correction. And never before have they had more ammunition at their disposal. The numbers are all over the place. And they're huge. The Obama administration, for example, expects to run $9 trillion in deficits over the next 10 years - and that number is based on a recovery! Imagine what will happen if the economy doesn't recover?

Here at The Daily Reckoning, we don't expect a recovery, not now...not never. Because the old model no longer works. Debt got too big...too expensive...too risky. Something had to give.

But what gives now? What happens when a world economy of $50 trillion per year tries to correct and governments try to stop it? What gives when the world's largest debtor borrows $9 trillion trying to prevent nature from taking her course?

Bill Bonner
for The Daily Reckoning Australia

• Painting for Good Money
• Does This Mean You Should Sell Your Gold?
• Where Bill Bonner Invests His Money
• Calling What’s Happening in the Economy a “Credit Crunch” is Misleading
• China Was the Maker and the United States Was the Taker

Markets still moving up...

Oil rose $2.50 on Friday...to $69. Gold rose $18 to $953. The Dow was up 18 points. And the dollar fell to $1.42 per euro.

And governments are still doing the wrong thing...trying to increase demand. It's not possible...for reasons we describe below...

Well, it's August...and we're on vacation. But just because we're on vacation doesn't mean the world stops turning. It just doesn't turn quite so fast.

"Why don't you just stop writing for a while?" our mother asked this morning. She is visiting for the summer.

"I don't know how you write every day anyway. You must say the same thing..."

Richard Russell has given a Dow Theory bull market signal. When you get a signal, he says, you don't argue with it; you go with it. Stock prices are going up.

We don't doubt it. The Dow would have to clime to about 10,300 just to give us a classic 50% bounce.

But we are in a depression. We don't gamble on stocks in a depression. It's too risky. Instead, we go with the flow. And the flow over the next 10 years or so is probably going to be down.

By our reckoning the Dow hit its high in January of 2000. Adjusted for inflation it's been running downhill ever since. Investors have made nothing for their trouble. And if we're right, they won't make anything in the years ahead either. Instead, they'll have to wait until stocks are cheap again.

You know, dear reader...investing is really very simple. Buy low. Sell high.

Okay...now that we got that figured out...let's move on...

Sticking with the basics, what we notice is that stocks, bonds and commodities move in broad patterns that last for many years. Not to put too fine a point on it, but they go up and then they go down. Or vice versa. Just looking at the last 50 years, stocks were very expensive in 1966. Then, they dilly dallied around for a couple of years...and headed down. This bear market continued until August 1982. That was when BusinessWeek magazine declared that stocks were not merely ailing, they were dead: "The Death of Equities" was the cover story that month. Naturally, equities got up from their deathbed the very next month and entered the marathon. They ran for the next 18 years.

Well, you know the rest of the story as well as we do. It's not complicated. The problem is that it takes patience to see it...to understand it...and to take advantage of it. The way to make money in stocks is to buy them when they are very cheap. But you may have to wait for 15-20 years. They're not cheap towards the end of the bull cycle. Since you never know exactly when it's going to end you don't want to buy anywhere near the top. So you wait...and then stocks keep getting more and more expensive. Finally, the top arrives...and then you have to wait another decade or more until they reach bottom.

"Well, why don't your write The Daily Reckoning once every 20 years?" mother wanted to know. "Just tell them when to buy...wait 20 years...and then tell them when to sell."

But we're going to ignore our dear, sweet momma this morning. She just doesn't understand the complexity of the financial world!

For the last nine years, stocks have been going down (albeit with a major countertrend to the upside). We'll probably have to wait another few years before they are cheap enough to buy. And when the end comes, stocks will be very cheap - between 5 to 8 times earnings.

When will that day come? Probably around August 15, 2018. Don't forget to read The Daily Reckoning that day!

Stock market cycles tend to coincide, more or less, with broad trends in the credit cycle. When people borrow and spend it causes business profits to grow. The businesses then expand; they hire more people; they build more capacity.

Then, when the credit cycle turns, everything goes in the other direction. People stop borrowing and begin paying back. Sales decline. Unemployment grows. Profits fall. Credit contracts.

We are now in the early stages of a major credit contraction. This is not a pause in a credit expansion; it is a change of direction, a credit contraction with all that goes along with it - joblessness, bankruptcies, foreclosures, and so forth.

Bloomberg tells us that the numbers have already been revised - downward. "Worst recession since the Great Depression," says its headline.

It is the worst recession since the Great Depression because it's not a recession at all; it's a depression. And the government is doing its level best to make it a great one.

The key to understanding a depression - or the downswing of the credit cycle - is that demand contracts. Consumers have less to spend. For a very simple reason: they already spent it.

Listen up, because this is important. When you borrow in order to consume, what you are really doing is consuming something today that you would have normally consumed in the future. You spend money you haven't earned yet on something you're not really ready to buy. You've heard the expression, 'time is money.' That's why borrowing money is really borrowing time. Later, you have to make it up. You have pay off the debt. When you do, you take money out of current consumption; you've already consumed it!

This is what economists refer to as "demand destruction." It's what happens in a depression. People are replacing what they took from the future. They're can't consume because they've already spent their money in the last boom. Demand collapses.

We've seen that happen in the last two years. Savings rates went from zero to 7%. Sales have declined (the latest revisions show them off more than was previously thought.) Profits are shrinking.

This is, of course, a completely natural and necessary adjustment. You can't take things from the future without putting them back eventually. The future won't stand for it. But the feds, in their benighted confusion, fight the problem like a farmer who plows backwards to fool the crows. They think the problem is too little demand. So, they try to add demand...with tax cuts...spending programs...low rates...easy credit...cash for clunkers and other fixes. What do these policies achieve? Do they really increase demand? No, they can't do that...that would require a richer population with more money to spend. What they try to do is to move demand forward.

The problem, of course, is that too much demand has already been moved forward. But they're nevertheless trying to steal even more of it...taking away demand that would normally show up two, three, four...ten years from now. That car that you might buy next year, for example. With the 'cash for clunkers' program, you might make the purchase now instead of waiting until you actually have the money. Or, that new parking lot behind the town hall. We won't really need it for a few years, but heck, if they're giving away money now... Or how about that trip to Europe? With a big tax rebate check, you might decide to take it on your 20th wedding anniversary, rather than wait 'til your 25th.

Real demand increases only when real wages increase. Then, people have more purchasing power. Trying to increase demand by borrowing - or stealing - from the future is a scam at best. Even if it works now, it fails later.

Bill Bonner
for The Daily Reckoning Australia

• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• What We Face Now Is a Depression
• At a Time When We Are Drowning in Debt, We Are Also Out of Money
• England Sinks Deeper into Depression in Decade of Pain
• Big Australian Resource Stocks Up 24% in 2008

How fast the bankers redeemed themselves...just a few months ago, we were making jokes about them:

"What do you say to a banker who has lost his job on Wall Street?"

"Uh...can I have fries with that?"

But now they're geniuses again. And they can prove it...just look at their pay stubs!

And if there's any fear that these dumbbells might blow themselves up again, you can forget it. They've got the full faith and credit of the United States of American behind them. Here's the latest from Associated Press:

"The watchdog overseeing the federal government financial bailout says the government's maximum exposure to financial institutions since 2007 could total nearly $24 trillion, or about $80,000 for every American.

"The whopping amount compiled by the inspector general for the $700 billion Troubled Asset Relief Program takes into account about 50 initiatives and programs set up by the Bush and Obama administrations as well as by the Federal Reserve.

"Many of the programs are backed by collateral and the $23.7 trillion represents the gross, not net, exposure that the government could face. No one has suggested that the full amount, in fact, will be used."

It takes our breath away. The feds are squandering money faster than we can keep up with it. Each time we think we've got it measured - the total doubles.

Twenty-four trillion is real money. It's getting close to two full year's worth of the entire output of the United States...

Is there any wonder Americans' hate bankers? They are chiselers and scalawags...making huge profits for themselves when the getting was good...and then whining for the protection of Uncle Sam when their own debt bombs blow up on them.

But hatred for bankers is cyclical. It follows the credit cycle.

Of course, bankers are always rogues and idiots. No doubt about that. But sometimes we like them and sometimes we don't. In the movie, It's a Wonderful Life, Jimmy Stewart plays the sort of banker we like. His bank made money the old fashioned way - by helping its clients finance houses and businesses. That's what bankers do on the upside of a credit cycle.

The business model is remarkably simple. So simple even a banker can get it. You borrow from depositors at one rate. And you lend to borrowers (who are also depositors, usually) at a higher rate. What could go wrong?

Well...that's what makes bankers bankers. They manage to mess it up.

Messing it up is pretty simple too. Deposits are a cost. Loans are a revenue stream. The more you lend, the more you make. Naturally, bankers have a tendency to lend too much. As the quantity increases, quality decreases. The most creditworthy borrowers get their money first. By the end of the cycle, borrowers are marginal...such as the people who got subprime loans in 2004-2007. They were often people without jobs...without assets...and with no fixed addresses.

Bankers lend too much in a predictable rhythm - at precisely the wrong time. They work with numbers and put on a good show. But when it comes to lending, they are all heart. Give them a good boom and they are ready to believe it will last forever. Booms raise asset prices. People borrow to expand and take advantage of the boom-like conditions. Bankers lend for the same reason - to take advantage of customers' willingness to borrow. So, they are inevitably drawn to lending most at the height of a boom...that is, just before it turns into a bust.

To this tendency towards self-destruction, you can add in the modern finance industry's delightful innovations - such as its leveraged derivative instruments. Making these available to bankers is like inviting a dipsomaniac for the weekend and leaving the liquor cabinet unlocked; it's asking for trouble.

But everybody loves bankers in the boom stage. They make it possible to buy houses...expand businesses...and become upstanding, slavish citizens. A man without credit might be a freethinker or even a troublemaker. But give him a mortgage and he will show up for work on Monday and vote in the next election.

In small towns, bankers are leading citizens. They sit on the boards of hospitals and churches. They write letters to the editor of the local paper. They contribute to political campaigns, often keeping an eye open...hoping their state senator dies so they will have a chance to take his place. People ask their opinions and are careful not to offend them. They play roughly the same role...and hold roughly the same status of the local priest. The priest reveals the mysteries of holy orders. The banker reveals to the locals the mysterious truths of economics. When the going is good, he tells them it is because of their hard work, thrift and discipline. When the going is not so good, he shuts up.

When the cycle turns, bankers are pariahs. Nobody hates a banker like someone deep in debt. And at the end of a credit expansion, people are more deeply in debt than ever. The poor banker has to stay at home and draw the drapes, pretending to have gone to Florida for the winter...or to be out of town on business.

Now you can see why busts are so important. They are like an intelligence test for bankers. The dumb and the greedy are eliminated. That is, unless the government steps in to save them.

Just a few months ago, Americans despised bankers. Could it be that the cycle has reversed itself so quickly? Are they now revered again? Are mommas once again urging their babies to grow up and be bankers?

We don't think so.

Our guess is that they will be chumps and schmucks for years to come. And we've got 20 trillion reasons why. Yes, that's the difference between what Americans owe bankers at the bottom of the credit cycle and what they owe them at the top. The debt cycle has just crested with an all-time high reading of debt/GDP of 370%. It will take many years of paying that debt down...and/or inflating it away...before Americans like bankers again.

The big question in our minds is this: how will that debt get reduced? Will Americans actually pay it down? Or will inflation come to their aid?

And what will happen to the trillions of dollars' worth of debt the feds are adding? The latest report from Congress estimates deficits as far as the eye can see...even to the year 2020, when they are supposed to be still 7% of GDP - or about $1 trillion. What will happen when this bubble in public debt blows up?

We wish the answer were easier. Two years...or even one year...ago, we could look ahead and see what was coming with a fair measure of confidence. There was clearly a bubble in housing and the financial sector. Surely it would pop.

Now, we look through the glass darkly...

The bubble has popped. The government as responded as we thought it would. The markets have bounced, as we thought they would.

But now what? We're waiting for the next leg down. If we're right...stocks will fall hard as investors realize that there will be no quick recovery.

And then... our visibility is poor... but the feds are bound to come back with Stimulus II. It will probably involve quicker-acting tax cuts. And it will probably cause more jitters in the bond market...and eventually, rising inflation levels.

When? How much? Hard to say...

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Interest Only Mortgage Option
• The More Money in a Financial System the Less Each Unit is Worth
• Bankers Pull Another Fast One
• Until This Debt is Reduced, Americans Will Be Reluctant to Borrow or Spend
• Why Do Men and Women Want Money and Power?

But listen up...an important announcement:

The bear market/credit crisis/depression is over!

How do we know? Abby Cohen says so. We read this in Bloomberg the other
day:

"U.S. financial markets have been moving 'back towards normal' since
March, said Abby Joseph Cohen, Goldman Sachs Group Inc.'s senior
investment strategist, in an interview.

"'Much of what we can recognize as happening now is really a
restoration of where we should be,' Cohen said 'This situation is much
closer to normal than any place we have been over the last 18 months.'"

Bloomberg does not mention it, but soldiers had more of a fighting
chance under George Armstrong Custer than investors following Abbey
Joseph Cohen. In August of 2007, she told CNBC that the S&P 500 would
rally to 1,600 by December. Then, in December, she predicted the S&P
500 index would reach 1,675 in 2008. In fact, the S&P 500 traded as low
as 741.02 by November 2008.

We wonder what they put in the water where Abby Cohen lives. The woman
always thinks stocks are going up, of course...but there is nothing odd
about that; she's paid to think stocks are going up. Of course, we know
better. We wouldn't touch stocks with a ten-foot pole.

But why does she think the situation is close to normal? What's normal
in her world? Deficits at 13% of GDP? GM goings bust? US presidents
running auto companies and banks? Bailouts...boondoggles...and baloney
equal to the entire nation's output?

If this is 'normal'...what's not?

We went to dinner with a group of Americans last night - at one of
London's oldest gentleman's clubs. Women are not allowed at the bar or
in many other parts of the club, but they may come for dinner in the
main dining room. Included was a young woman:

"I have a lot of friends who are just getting out of college. None of
them has gotten a good job. Instead, they're all moving back in with
mom and dad. And some of them are in their mid-'20s... It's very
depressing."

It's a phenomenon known as household compression. Households expand and
contract with the credit cycle. The '80s, '90s and early '00s were a
time of household expansion. Families broke up. Men and women
separated, setting up house in different places. The average house size
went up...but the average number of people per household size went
down!

Now, those trends are reversing. Children are moving in with
parents...spouses are moving back in with each other...old folks are
staying put. Multi-generational families are becoming more common.

We don't have any statistical proof of this. But it makes sense. And
it's not a bad thing. We've had a multi-generational household for many
years. Grandmother, parents and children all in one house. Everyone
seemed to benefit from it.

From around the world comes more evidence that the recession isn't
ending soon.

Bloomberg reports:

"German exports in April were 4.8 per cent lower than in March, and
28.7 per cent down on a year earlier, official figures show - the
steepest annual fall since records began in 1950, although officials
said that April 2008 had been exceptionally buoyant."

Meanwhile, from China, comes news that the world's most dynamic economy
has lost some of its old vim and vigor. Chinese exports are down too -
26%:

"China's exports fall by record after global demand dries up," reports
Bloomberg.

But what's this? The New York Times says China is on a "commodity
buying spree."

How could China import so much copper and iron ore when it's not
exporting finished products? Iron ore imports into China, for example,
are running 27% ahead of 2008. What are they doing with the raw
materials?

This story from Maritime Global News helps explain it.

"...could be the fact that domestically produced iron ore in China is
of a rather poor quality and quite expensive when compared to spot
imported prices. Another explanation could be that of speculators
getting into the import market to try and get hold of 'cheap' iron
[ore] that would possibly be required under the Chinese government's
US$586bn stimulus plan. And a third could be the impending conclusion
of the iron ore contract price negotiations."

Whatever the explanation... China may be importing raw materials, but
it is not selling them. Neither is Germany. And neither is Japan, whose
economy is shrinking at a 14% rate. So here's a question for Abby: How
can you have a global rebound when the world's three biggest exporters
aren't exporting?

They're not selling because the usual buyers aren't buying. Consider
this:

"Hiring Plans Stick at Record Low," begins a MarketWatch story.
Employers' plans to add jobs were at an all-time low in the second
quarter. Now, according to Manpower's latest survey, they're still at a
record low.

And today comes word that foreclosures topped 300,000 last month - for
the third month in a row. At this rate, three and a half million houses
will be foreclosed this year.

No jobs, no income. No income, no buying. No buying, no real boom. No
real boom, stocks head down. Why complicate it?

Gradually, Americans are waking up. They are rubbing the sleep from
their eyes and wondering what they were thinking when they gave the
Bush and Obama administrations their credit cards.

"This isn't a temporary stimulus but a ramp-up in debt followed by a
greater explosion in spending and debt," said Congressman Paul Ryan to
Fortune magazine. "The bond markets will come after us with a
vengeance. We're playing with fire."

Playing with fire? Yes...in a refinery!

Fortune says that over the next 10 years federal deficits will add
$90,000 in debt to the average tax-paying household's burdens, bringing
the total to about $155,000 per household. Fortune is underestimating.
It's likely to be much, much more. We hope you're prepared, dear
reader. Our friend and colleague, Rob Parenteau, at the revamped
Richebächer Letter says there's a "triple time bomb" yet to hit the
market that will make recovery nearly impossible.

Obama may talk about taxing the rich. In fact, there aren't enough rich
people to pay the tab for US spending; the middle class will have to
put on the yoke.

"The revenues needed are far too big to raise from high earners," says
Alan Auerbach, an economist at the University of California at
Berkeley. "The government will have to go where the money is, to the
middle class." The most likely levy, says Fortune: "a European-style
value-added tax (VAT) that would substantially raise the price of
everything from autos to restaurant meals."

But wait, there's more...

The American middle class can't really pay these debts.

They were living hand to mouth even in the Bubble Epoch. Now, jobs are
disappearing and incomes are going down. How would they possibly keep
up with the interest, let alone pay down the principal, on an
additional $90,000?

We quoted estimates that taxes would have to go up by 60% to balance
the budget by 2019. As we said then; that ain't gonna happen.

Instead, the US is headed for bankruptcy. And that begins with higher
interest rates, as lenders try to protect themselves from the risks of
default and/or inflation.

Fortune: "The risk that the U.S. will follow Britain, which was warned
recently that it could lose its triple-A bond rating, has risen from
virtually nil to a real possibility, judging by the sevenfold jump in
the cost of insuring Treasury debt in the past year. The big borrowing
is already spooking the bond markets. This year rates on 10-year
Treasuries have jumped from 2.2% to 3.7%. A further increase in rates
would aggravate the situation, raising the interest costs on the debt
and increasing its size even more."

Allan Meltzer, the distinguished monetarist at Carnegie Mellon: "I
predict far higher rates over the next few years."

Fortune continues: "Under George W. Bush, the U.S. experienced a
prelude to the crisis before us: Spending rose rapidly, while revenues
remained reasonably flat. Bush created an expensive new entitlement,
the Medicare drug benefit (cost this year: $63 billion), and let
spending on domestic programs from education to veterans' benefits run
wild. Over seven years the wars in Afghanistan and Iraq added a total
of some $900 billion to the budget. All told, Bush raised spending from
18.5% to 21% of GDP, setting in motion a chronic budget gap by piling
on new spending without paying for it.

"Under Obama the Bush trend keeps going, but this time on steroids..."

Trying to be a responsible pater familias, and having passed the age of
60, we took the rather reasonable decision to put our affairs in order
for the benefit of the next generation. The effort quickly became an
expensive nightmare of lawyers on three continents.

For your amusement we enclose an actual email message we just received.
It is a conversation between five lawyers...each billing at top rates.
This is a very private communication, but what difference does it make?
As near as we can make out, it is written in code so that neither the
client nor the general public can understand it:

"The concept you outline below is workable from US Estate Planning
Perspective, and makes sense as the way to meld the various goals, both
tax oriented and non tax oriented, together. If Bill confirms that this
concept is worth developing further, then I understand that Penny and
you will produce a first draft.... Some brief further details:

"(1) The QTIP Marital Trust for Elizabeth MUST distribute all income to
her during her lifetime after the demise of Bill, and must have within
the text [as you probably know] other tax oriented provisions. The
professional trustee having discretion with regard to distribution of
income to Elizabeth will not work, but having discretion with regard to
capital distributions is ok. Sarah can send sample language for a
'standard' QTIP, if you want. Please advise.

"(2) The marital deduction trust in Elizabeth's Revocable Trust is a
QDOT, not a QTIP... It is not a model to be used in Bill's Trust to
provide for Elizabeth if Bill attains his reward...and is survived by
Elizabeth.

"(3) Sarah is producing a Summary of US estate, gift and GST tax
attributes with regard to Bill. We hope to send that in the next day or
so, to serve as a general orientation, and to make sure that we are all
reading from the same page.

"(4) It appears, however, as if the 'applicable exclusion amount' [the
exemption from US federal estate tax] for a person like Bill may be
very small...while the exemption from GST tax might be the 'normal'
$3.5 M. If we confirm this, then the structure that needs to be used
[we believe; subject to confirmation] is a QTIP Marital Trust A and a
QTIP Marital Trust B. BOTH qualify for the marital deduction; both
function to postpone the federal estate tax on Bill's demise until the
assumed subsequent demise of Elizabeth. But 'A' captures the amount of
the GST exemption in excess of the 'applicable exclusion amount', and
'B' is funded with all property in excess of (i) the [small] amount of
the applicable exclusion [which we agree remains throughout in the main
trust; see the fourth sentence of your paragraph 4 immediately below]
and (ii) the amount that funds 'A'. Then upon Elizabeth subsequent
demise, ALL US federal estate tax is paid ONLY out of 'B' [this is
permitted if the document stipulates to this effect], allowing 'A' to
pass back to the [now irrevocable] main trust [see the third sentence
of your paragraph 4 immediately below] wholly protected from all future
GST tax.

"(5) The 'A' vs. 'B' structure preserves the full amount of the GST
exemption, and to that extent 'solves' the GST issue which you refer to
in your paragraph 8 immediately below, and which was identified in jjr
email in paragraph 6 and 7 from June 5 at 1:27 pm further below.

"(6) If we confirm (4), then Sarah will send sample language regarding
the A vs. B QTIP structure...etc."

With all this hassle, it is hardly worth dying.

Bill Bonner
for The Daily Reckoning Australia

• Predictions for a Polite and Mild Recession
• Forgetful Bill
• Australian Recession in the Works? Ask the Sharemarket
• America’s Service Industry is responsible for Low Wages
• The Collapse of Gold and Commodities

"What's going on? When will this be over? How bad do you think it will get? What can we do to turn this around?"

Members of Congress have the same questions the rest of us have. They read the same claptrap in the newspapers. They hear the same balderdash explanations from economists and federal officials. They're wondering what is really going on.

Not that we know. But they asked us anyway.

We report to you today from the banks of the Potomac. Our old friend, Congressman Ron Paul organized an off-the-record discussion with several other members of Congress. The subject was the financial meltdown...and the bailout. We were there to talk, of course, but we were more interested in listening.

"You don't understand," said a Senate functionary we met later, "these people live in Bubble World. They're protected from the real world by their staffs and by the system itself. You imagine that they would know what is going on. But they don't. They know less than we do. And they'll be the last to find out. They are so busy meeting constituents...dealing with donors...working out deals with their political parties and supporters...and feeling like big shots...they don't really have any time to study the issues. So they count on staff and party committees to tell them what to say, how to vote...and what to think."

Waiting in the corridor of the Cannon building, two men in grey suits walked by...we overheard this conversation:

"Did you vote 'no' on that last resolution? You were supposed to vote 'yes.'"

"I thought I was supposed to vote 'yes' to cutting off the argument...as far as I'm concerned we've heard enough about Nancy's problem with the CIA..."

"But that wasn't about cutting off the debate, that was just technical...about allowing them to modify the previous vote..."

"What are you talking about?"

"I don't know...I didn't think it had anything to do with stopping all this gabbing about Nancy and the CIA..."

We take it for granted that members of Congress often don't know what they are talking about. But it is shocking to realize that they often don't know what they are voting on either. And neither do the voters.

The Economist reports, for example, that the measures put before California voters in a recent plebiscite were challenged...not by the courts, but by a grammarian. She claimed they were worded it in such a way that it was impossible for a reasonably intelligent person to understand what they were supposed to mean.
Since the meeting was "off-the-record," we can't tell you who was there or what they said. We can only report what we had to say.

"Look...economies...and empires...go in cycles," we began. We thought we ought to start with the basics, since we didn't know what they thought.

"Growth...maturity...then, decline. That's just the way it is. So in order to get an idea of what lies ahead you have to figure out where you are in the cycle.

"You never know for sure, but there are tell-tale signs. The credit cycle, for example, has been on an upswing in the US since the Great Depression. First, there was in-store consumer credit as early as the '20s. There was some mortgage credit...and some margin credit for investors too. But during the '30s, the financial strain was so great that most people regretted their debt and paid it down. Or they defaulted.

"You could get a mortgage back then if you put 50% down...and paid it off in full in 3 to 5 years. And then Franklin Roosevelt set up the FHA...along with Fannie Mae. And pretty soon, you could borrow 80% of the house price and pay it off over 15 years.

"Major credit cards - MasterCard and Visa - didn't become widely used until the '60s. And then, credit began to rise more steeply. Total debt had been about 150% of GDP in the '50s and '60s...but it rose quickly after the '80s. By the 2000s, you could get a mortgage for 110% of your house price - an inflated price at that. And you could take 30 years to pay it off.

"As for credit cards, hardly a day passed when you didn't get a new one in the mail...usually with a higher debt limit. Debt rose...and rose...and rose...up to 350% of GDP. And finally, the whole debt bubble blew up.

"You have to remember that the US economy - in fact, much of the whole world economy - came to rely on more and more debt as a way to expand. At first, a fellow could borrow $1.50...he'd spend it and invest it...and it would lead to an increase in GDP of $1. But, as time when by it took more and more debt to produce more GDP. The fellow would borrow a $1.50...but then, part of it would have to be used to pay the interest on what he borrowed before. Eventually, it was taking more than $6 to produce a single ounce of GDP.

"You can see that this won't work for long. GDP is like national income. You can't have debt increasing 6 times faster than income - at least not for long.

"But remember, the US economy depended on this debt-fueled growth. Without the extra credit, the economy would slip back...which is what is happening now.

"We've reached a turning point. The financial industry has blown itself up. It realized that all those credits it had, from people who didn't have the cashflow to repay their debts, weren't worth what they were supposed to be worth. We're now on the downhill slope of the credit cycle...and most likely, the imperial cycle too.

"What everyone wants to know is how long it will take before we have a genuine recovery. And then, everyone...everyone...seems to think that the government can stir up new growth by pushing more debt onto the public...this time, public debt. And get this...the feds are now adding debt to the system at a rate four times greater than the previous record.

"They...you...are running a budget deficit of $1.8 trillion this year. Could be higher. How much in extra GDP do you get from all that extra debt? Well, that's a good question...because GDP is now going backwards. The latest numbers show output going down at a 6% rate in the US. And that's one of the world's better rates. Exporters - notably Germany and Japan - are doing much worse. GDP is falling 14% in Germany. It's going down at a 15% rate in Japan.

"So, the feds are adding trillions in new credit (debt) and getting no GDP growth from it - zero...zilch...nada. In other words debt is growing infinitely faster than GDP.

"How long can this keep going? No one knows. But one thing we do know is that the economy is not going to start up again and deliver good, old-fashioned, healthy growth. We're in the process of deleveraging. That is, we're on the downside of a credit cycle. We're getting rid of debt, not adding to it."

If we'd had today's newspaper in front of us, we would have pointed at the headlines.

"Recession Turns Malls Into Ghost Towns," says the Wall Street Journal. Malls are emptying out because they were built for a world that no longer exists. They were built for a world where people increased their debt and their consumer spending far faster than they increased their real incomes. Now that people are cutting back on spending - in order to reduce their levels of debt - they can no longer afford to go to the mall. As a business or an investment, malls have got to be bad places for your money.

"The private sector is not going to take on more debt," we continued our explanation. "People know it doesn't pay. And they've got too much already. The private sector is not going to begin a new growth period until they've paid off, worked out, defaulted on, or shirked a lot of their present debt load. We've estimated that they need to get rid of about $20 trillion worth. And that's going to take time. And a lot of painful decisions by a lot of people. Bad business, investment and spending decisions need to be recognized...and fixed. Debt needs to be reduced.

"And that's why this downturn is not going to end tomorrow."

If we'd had the mall example in front of us, we could have explained that a mall represents a kind of bubble-era investment that now needs to be restructured. After America's industrial age was over, the country found itself with empty factories and warehouses. They were mostly written off and destroyed. Some were converted - into lofts and shopping malls. Now that the retail age is over, we'll have to find new uses for malls too.

"This is going to take time," we told them...and then we took a break to listen...and eat some shrimp.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Statistically One Vote Doesn’t Make Any Difference
• Commercial Real Estate May Be the Next to Fall
• Fire Chief Bernanke
• Leave it to Congress to Use “Christmas Tree” as a Verb
• Markets Rise While the Economy Sinks

This is very good news. It means you will have a chance to buy gold at lower prices before it goes up higher later this year. Much higher, in fact, according to the 2009 forecast made by Diggers and Drillers editor Al Robinson. Look for Al's special gold forecast issue later today in your in box.

Not everyone agrees that gold is going higher, mind you. "The deflationary scenario is still incredibly intact, even though the government has thrown trillions of dollars at it," one Leonard Kaplan told Bloomberg. Kaplan is the president of Prospector Asset Management in Evanston, Illinois. "Gold has a long ways to go down," he added.

Daloob. Seriously daloob. Daloob is a word that means whatever you'd like.

But what does it mean to say that the deflationary scenario is "incredibly" intact? Does this mean that the scenario is "not credible?" Or does it mean the scenario explains and predicts what's ahead? The statement is incredibly opaque.

Either way, the deflationary scenario that Kaplan refers to is worth a few lines. The scenario is one where commodity and stock prices fall as the credit depression gets its hands around the neck of the economy and squeezes. Under that scenario, gold would fall. And under that scenario, the cost of paying off debts would rise massively as cash gained value. Old debts would become economy-killing burdens for households, businesses, and, dare we say it, governments too.

In fact, the real economic consequences from this kind deflation are so destructive that we would bet our left big toe that the Federal Reserve is going to do everything in its power (and perhaps some things not in its power) to prevent it. It's not a risky bet. The Fed is firmly moving down the path to monetary weirdness. We are well and truly down the rabbit hole in 2009.

In the meantime, falling commodities prices are telling you that the forecast for the economy in 2009 is not good. Gold, oil, metals, and grains all moved down yesterday while the U.S. dollar moved up. It will be worth watching if commodity shares follow commodity prices down. Commodity shares, as we know all too well, were decimated in 2008.

But based on some analysis from our old friend Dr. Marc Faber in his latest Gloom, Boom, Doom report, commodities as an asset class are about the only stocks actually in a similar position to where stocks found themselves in 1987. That is, while the entire market was savaged last year, commodities may be the only sector worth taking a punt on in 2009, based on Dr. Faber's analysis of previous bull and bear cycles in various asset classes.

What cycles? Faber says that the length of the cycle immediately preceding a correction or crash has a lot to do with what you can expect next. "If an up-cycle was brief," he writes, "the down-cycle is also likely to be brief. If the up-cycle lasted a very long time and was accompanied by huge excesses, the downturn from the peak of such a cycle is likely to be lengthy-as was the case for gold after 1980, and for the Nikkei and the Japanese economy post-1990. Similarly, if a down-cycle lasted a long time (20-30 years), the up-cycle is also likely to last for an extended period of time."

The bull market in commodities began in 1999 and was preceded by an infamous 20-year bear market. Equities, on the other hand, enjoyed an 18-year bull market from 1982 to 2000, but have been in a bear market since then (with a robust, credit-induced bear market rally from 2003 to 2007).

By that logic, the down-cycle in equities should be a lot longer because the up-cycle preceding it lasted so long. On the other hand, the down-cycle in commodities should be shorter because it was preceded by a much shorter up-cycle and a very long down-cycle. Stocks down. Commodities up. Got it?

But is it right? The reasoning makes sense, especially if you compare it with the historic numbers Dr. Faber presents (which we will not replicate here for the sake of space). But there is a simple objection that must be dealt with. What if the commodities cycle is itself a function of an even larger cycle, namely the credit cycle?

If you argue that the bull market in credit began in 1973 and a world of floating exchange rates and competitive currency devaluations (or 1913 when the Federal Reserve was founded, or 1694 if we want to go all the way back to the Bank of England again), then the direction of asset prices would be dictated by whether credit was in an up-cycle or down-cycle.

It's pretty safe to say that credit appears to be in a down-cycle, starting in August of 2007. What's more, it was preceded by a massive "up-cycle" in which the supply of money and credit grew globally. That "up-cycle" drove up all assets in all countries simultaneously. We will find out this year if another "up-cycle" can be artificially by Obama and Bernanke.

But if we are now in the "down-cycle" for credit-the Credit Depression-then how can commodities possibly outperform equities and rally while stocks fall?

Well, the only possible way for commodities to go up in price during a credit depression when global economic activity shrinks...is if we experience massive, central-bank backed money printing and the inflation that ensues. Not that this is an outcome we find desirable. But it's clear as day from the Fed's actions and words that it will produce inflation at any cost to prevent being crushed by debt and deflation. For all its real wealth destruction, the Fed appears to prefer hyperinflation to credit depression.

And don't worry that the Fed is out of interest rate bullets in its pursuit of reinflating the credit bubble. There are other weapons. It will mail checks directly to people or buy assets directly on stock markets. You can expect the debt-to-GDP ratio in the United States to approach and exceed 100% before Obama's first term is over. You can also expect to see more direct government asset purchases and intervention in markets.

How can we be so sure that we're on the verge of a brave new world of government-managed markets and economies? It's simple. Central banks and national governments the world over face an existential crisis-the loss of public confidence in paper money. Action must be taken to restore confidence or real economic activity (lending, borrowing, spending, and investing) will grind to a halt.

Perversely, the monetary authorities will destroy public confidence completely through massive inflation. It will also unleash a great deal of social and political disorder. But the authorities appear to prefer this chaotic result (which they can then police and manage with new rules) to another Great Depression characterised by too little money and price deflation. The excesses of the credit bubble will not be liquidated. Instead, they will be perpetuated and subsidised. The resulting economic and social disorder will be met with more State activity in your personal and economic life.

All of this is a long way of explaining why the current lull in the gold price is a great buying opportunity. You know the tactics and strategy of the central bankers. And you have a pretty good idea that any rally in the stock market is a fake out rally, not sustainable based on the economic forecast OR previous cycles (where markets are coming off 20-years of rising prices). What you don't know is if gold prices are going to fall further before eventually heading higher.

To find the answer to that, you can consult 1974. At that time, stock markets looked oversold and gold had begun to move and was on the verge of a correction. "If someone really felt that the similarities between the 1974 low and the current market conditions are overwhelming," Dr. Faber adds, "he should consider purchasing gold and oil rather than U.S. equities (and also shorting U.S. bonds)...Gold corrected between the end of 1974 and the summer of 1976 by 40%, while the stock market surged. But from its August 1976 low, the gold price increased eight-fold."

"If we are really in an environment such as we were in at the 1974 lows (and I have serious reservations about this assumption), then we should expect some further weakness in gold prices when equities rebound. Such weakness would then provide an excellent buying opportunity."

"However, keep in mind that even if you bought gold at its 1974 high at US$196 per ounce, by 1980 you would still have quadrupled your money, which was far better than the return the stock market provided. So even if you endorse the view that we are in a similar situation as in 1974, I would be reluctant to stay out of the gold market entirely in the hope of buying it at lower prices."

"Another reason why gold may not sell off as much as it did between 1974 and 1976 is that governments' interventions with monetary and fiscal measures around the world are unprecedented. ..Therefore, based on my time/cycle analysis above, commodities and commodity-related shares would also seem to be in a far more favourable position to resume their up-trend than broad U.S. equity indices, which (a sharp rebound aside) are unlikely to enter a sustained longer-term bull market."

If Faber is right, what will it mean for Australia's broad equity indices? Well, you'd expect them to go higher as commodity prices react to the increase in global money supply. It certainly seems like most of the deleveraging is done in commodity stocks, meaning it would take something monstrous for mining shares to retest the 2003 lows.

Monsters are real though, so we can't completely discount the possibility that 2009 will be worse for resource shares than 2008. However, one needn't be a raging bull on Aussie resource stocks to see that the case for gold looks good. It's distressing that gold looks so good because the outlook for the economy is so bad. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Oil Was Down and the Banks Were Up
• Less Gold is Being Sold by European Central Banks
• Why the Bull Market in Commodities Isn’t Over
• Teach Your Children Chinese Because China is the Next Great Country

Yesterday, we mentioned that clothing prices were on the rise. Today, the Wall Street Journal says shoes are taking a hike upwards.

Here in London, inflation is at its highest level in six years. In China, 8% consumer price inflation is spooking the financial authorities. And import prices in the United States jumped 1.8% in April.

Why would imports be going up so fast?

Ah... glad you asked. Because that is what is really not "normal" about the latest tremors. For 20 years, inflation has been held in check by the group of happy events we described above. But what will hold it back for the next 20 years?

China used to export deflation, as the economists put it. Now, with prices rising in the Middle Kingdom, it has no choice - it must export inflation. With inventories at 30-year lows - there are no price cuts coming from there either. Wages are rising. Raw material prices are soaring. Food is out of control.

But wait, there's more...

Remember the great credit expansion of the last quarter century? For 25 years, the cost of money got cheaper and cheaper and cheaper... to the point where the Fed was lending money at negative real rates (and still is!) In 1982, the yield on a 10-year Treasury note was nearly 16%. Today, it is under 4%.

But now, money is becoming more expensive. If the credit cycle has turned, as we think it has, lending rates will go up with inflation. And the cost of money... along with the cost of other essential components... will drive up prices for nearly everything.

What will the U.S. consumer do? He has little prospect of higher wages - not with so many billions of people willing to work for less. His main asset is falling in price. Credit is getting tighter. And his cost of living is going up - maybe sharply up.

This time he won't be able to borrow his way out. This time, more credit... lower rates... and more inflation won't help him. This time, inflation will hurt him.

Bill Bonner
The Daily Reckoning Australia

• BRIC – Brazil, Russia, India and China Suffer High Rates of Inflation
• Inflation is an Artifice Caused by Government
• Lending Money Below the Inflation Rate
• Still Opportunity in Emerging Markets – Especially India
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit