'Yes...we sold a lot of toxic, explosive stuff to our clients,' they said.

'Yes, we used our own money to bet against them...' admitted Goldman's top man.

'Yes, we blew up the whole world economy. We're sorry.'

Associated Press reports:

"The bankers - whose companies collectively received more than $100 billion in taxpayer assistance to weather the crisis - offered no regrets for executive pay that is now likely to increase as a result of their survival...

"Lloyd Blankfein, the chief executive of Goldman Sachs, took the brunt of the questions, especially on his firm's practice of selling mortgage-backed securities and then betting against them.

"'I'm just going to be blunt with you,' Angelides told him. 'It sounds to me a little bit like selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars.'

"Blankfein replied: 'I do think the behavior is improper. We regret the consequence that people have lost money in it.' Later, though, he defended the firm's actions as 'exercises in risk management.'"

This is not the first time we've seen this show. We're not old enough to remember the Pecora hearings of the 1930s. But they shared the same story line: captains of industry and finance make blunders; they cause Great Depression; politicians save the day.

Back in the '30s, the guys hauled before Congress generally refused blame. They were just doing their jobs. By and large, they were right.

This bunch today is more media savvy. They realize that their power and money come at a price. The feds have to pretend to punish them; they have to pretend contrition.

And the rest of us can only enjoy the show. After all, it's the greatest show on earth. We love every minute of it. But it's only entertaining when you understand the real plot.

What's the plot?

Well, you already know it. After the bubble blew up, the feds swung into action to repair it. But you can't really fix a bubble...at best you can only create a new bubble.

The real economy is still deflating. Just look at the jobs situation. Far from slowing or stabilizing, 2009 was the worst year yet for job losses - '07...'08 ...and '09...each year has produced greater losses. Even James Grant, who predicted a "barn burning recovery" now admits that his forecast has gone up in flames. He was "either early or wrong," he says.

And just look at the real estate market. "Home prices are softening again," says David Rosenberg. As for commercial real estate, here's Kenneth Laub, who's been in the business for 50 years, as reported by Bloomberg:

"He says the current downturn will overshadow all of the others...

"'It won't be a typical part of a cycle where we're down for two or three years and things recover,' says Laub, 70, whose New York firm, Kenneth D. Laub & Co., says it has handled more than $40 billion of real estate transactions since its inception in 1969. 'It will be longer than we've gone through before.'

"As in past slumps, the weak US economy is curbing demand for commercial space, increasing vacancies and causing rents and property values to fall. The key difference today is the explosion in debt financing and related derivatives that fueled a run-up in commercial real estate prices in the 2000s, Laub says. That's left property owners struggling to make mortgage payments. The overhang of debt will delay any recovery, he says.

"'It's not a supply-demand thing; it's an overleveraged condition,' Laub says.

"Laub expects a wave of restructurings by troubled commercial borrowers as hundreds of billions of dollars of loans come due annually during the next few years. Commercial real estate may still be recovering a decade from now, he says. 'What you're going to see is a tremendously long workout period unprecedented in commercial real estate in this country,' Laub says. 'That's where we're going, and it's just beginning.'"

Bad property market. Weak employment market. That's the background. And it will probably last for years - until the extraordinary debt in the private sector has been worked down to more comfortable levels.

Against this natural process of de-leveraging and depression struggle the feds - our heroes...making the situation worse! More below on that too...

Instead of blaming themselves for their silly theories...for causing the bubble with artificially low interest rates...and then failing completely to understand what they had done...they blame Wall Street.

Sure, the bankers, more knave than fool, took advantage of the situation. But they didn't cause it.

Still, they're very sorry they almost brought modern civilization to an end...but, hey, business is business...

Oh the roar of the greasepaint...the smell of the crowd! What a circus!

Obama says the feds 'saved' 2 million jobs. But the cost of each job saved was as much as $65 million, according to our not-very-precise accounting.

Was it worth it?

Yesterday, we went on at some length as to why government jobs weren't the same as private sector jobs. Since they're never put to the test of the market, you never know whether they are worth having, let alone saving. Do they add to the sum of human wealth and happiness...or do they subtract from it? No one knows for sure.

But here's the strange and remarkable thing; modern economists actually would prefer jobs that are NOT worth doing.

In the twisted mind of a mainstream economist the problem in a depression is that people don't spend money. Since they don't spend, demand goes down. The secret to avoiding a depression, they believe, is to replace private demand with government demand.

Easy, peasy...right?

The government just spends more money. And since it doesn't have any more money to spend (practically every government on earth was already running a deficit), it borrows the necessary funds. Thus does demand go up. And thus do the feds create the next bubble - in public debt.

But what if government-funded stimulus projects actually produced goods and services that people wanted? Ah...that would be a problem. Because in a depression, there is too much supply and not enough demand. Prices fall, encouraging people to delay spending...further depressing demand...and causing an even worse depression. So, the last thing the feds want is more supply. They want more demand but LESS supply. That means that the ideal government project is one that doesn't produce anything worth having. Such as military spending. Or digging holes and filling them up again. Or, departments and agencies that employ people who don't do anything.

It sounds to us as though practically any government program would fill the bill!

Regards,

Bill Bonner
for The Daily Reckoning Australia

• We’re Not Threatened by Inflation but by Depression
• Government Pretends to Punish the Bankers
• Hidden Inventory of Unsold Houses Will Depress Housing Prices
• We Trust Gold Because We Don’t Trust Central Bankers
• Gold Doesn’t Always Need Inflation to Rise

Most people find it both galling and absurd to see the bankers getting $10 million bonuses while there is 10% unemployment. Here at The Daily Reckoning, it's just a matter of curiosity. You'd think there would be more wage competition to drive down bankers' compensation. Why doesn't Goldman go to an unemployment line and make an offer...

"Any of you guys want to earn a $9 million bonus?"

Surely there would be a few takers. And Goldman would save $1 million.

Of course, we're joking. Banking is not a trade you can pick up just like that. Borrowing from the Fed at 1%...lending back to the Treasury at 4%...hey, it must take a few days of training to be able to turn around money like that.

On the other hand, there are periods when speculating for a big bank is a breeze. Over the last 7 months, for example, there was almost no way fed-financed traders could lose money. They borrowed dollars - the new carry-trade funding currency - at next to zero interest. It didn't matter what they did with it...they could trade it for Brazilian reals...or buy stocks in Singapore...or buy gold. Almost everything went up against the dollar.

Institutional investors - such as those managing money for banks - are judged on how well they do against the benchmarks, the averages, not on how much money they make or how many losses they avoid. If their colleagues are making money, they have no choice. They have to get in the game too.

So, they're in a "doom loop," where they continue to bid up asset prices - even at the beginning of a depression.

Meanwhile, over in the real economy...the deflation continues. David Rosenberg:

"It is like a magic show - the US economy is somehow out of recession with both employment and consumer credit outstanding still in full- fledged contraction mode.

"In September, total consumer credit fell $14.8bln making it the eighth month in a row of debt repayment - an unprecedented string of declines. Over this period, the amount of consumer credit (not including mortgages) that has come out of the system has totaled $163bln at an annual rate (or -6.3% at an annual rate). Looking at the fact that total household debt still exceeds long-turn norms of 60% by a factor of more than two, we are still in the early stages of a secular credit contraction that could well end up seeing another $5 trillion of debt collapse. This is a highly deflationary process; it will take time; and while we are bullish on gold and commodities strictly on global supply- demand imbalances, bonds remain a very good place because deflationary episodes provide solid real yields to investors."

Let's see. We've tried several ways to gauge how long it will take to de-leverage the private sector (which is another way of figuring how long this depression will last). At 6% a year - assuming private sector has about 2 times as much debt as it should have - it will take about 7 years to get down to a more comfortable level?

Did we do the math right? Well, who knows? But every time we do it, we come up with about the same answer - 7 to 10 years, more or less.

But it's not that simple. Because as the private sector de-leverages the feds try to prevent it...while they leverage up the public sector. This is bound to stretch the whole thing out...and bound to lead to some serious bust-ups.

Bill Bonner
for The Daily Reckoning Australia

• Government Pretends to Punish the Bankers
• Baby Boomers Face Early Retirement With No Money Saved
• Fed Made More Money than Goldman Sachs
• Feds Want to Increase the Money Supply and Induce People to Spend Money
• How Does an Economy Expand When the Banks are Lending Less Money?

The financial crisis of '08-'09 was not a head cold. It didn't go away.

It was more like diabetes, a stroke, or cancer. It was serious. Life threatening. We may not recover. Our only hope is to change our habits, undergo some nasty treatments...and endure a long convalescence.

But that's not what most people think. They are convinced that the feds gave the economy a miracle drug. It cleared up the trouble lickety split. Now, our troubles are behind us.

The Dow moved up 17 points on Friday, leaving it above the 10,000 mark. Gold rose too - it is at a new record high, only $5 below $1,100.

According to the news reports, the US economy is 'growing' again. Yes, that's the official storyline.

But wait, what kind of growth is this? David Rosenberg:

"All we can say is that if the overwhelming consensus is correct that the recession is behind us, then what we have on our hands is the mother of all jobless recoveries and whatever economic growth is being squeezed into the system comes courtesy of the most dramatic intervention by the government in recorded history, including the New Deal 1930s era. President Obama is now running fiscal deficits that would have made FDR blush."

The quacks at the Fed and the Treasury department have delivered the biggest jolt of adrenaline in history. People in the private sector won't spend? Heck, the feds will spend for them!

It took the Fed nearly one hundred years to grow its balance sheet - which is the foundation of the US money supply - to $800 billion. Then, after Lehman Bros. went broke, it doubled its balance sheet...to more than $1.8 trillion.

Early last week, the Fed announced that it would keep the firehose- sized IV in place. Then, by the end of the week, the G-20 meeting of finance ministers confirmed said they were all sticking with their stimulus programs.

You can't put that much cash into a financial system without getting some kind of reaction. Goldman is making record profits, for example. How does Goldman make money? It is finance business. It profits by offering credit. When credit expands, the moneylenders and speculators at Goldman make money.

The private sector isn't borrowing. Every day brings more proof.

Consumer credit contracted again in September - the 8th month this year.

Unemployment just passed the 10% mark, reports The New York Times.

"Small Businesses Hunker Down to Survive," says another headline story.

Another big bank went bust in California.

But while the private sector de-leverages, the public sector expands. Now, it's the feds who are doing the borrowing - about $1.7 trillion this year.

This is great for the people who help the feds finance their spending. But all it does is add more debt to the system. And debt is the real problem.

If former OMB director David Stockman is right, we'll see deficits over $2 trillion for a decade.

What people once took for absurd they now take for granted. Such as trillion-dollar deficits. For even with a hole in public finances equal to 13% of GDP the US House of Representatives passed a law overhauling the health care system, at a cost of more than $1 trillion.

What were they thinking?

Well, they were probably thinking that 'deficits don't matter.' And they were probably justifying the expense on the grounds that it was 'countercyclical spending' that would help pull the US out of its slump.

Whatever they were thinking, they weren't remembering what happened 20 years ago. It was 20 years ago today that the Berlin Wall fell, bringing to an end a 40-year demonstration project. The East Germans/Soviets wanted to show the world how well economists working for the government could run an economy.

And we found out!

Bill Bonner
for The Daily Reckoning Australia

• Government Debt
• Bankers Take Money From the Government and Use it to Speculate
• Government Pretending Debt-fueled Spending is the Same as Growth
• Feds Have Used the Correction to Increase Their Power and Add to Their Wealth
• Why Weren’t Economists On Top of This Thing?

But along came two very important bits of information.

First, we got word that the crisis was officially over. GDP grew last quarter. Thanks to all the Cash for Clunkers, Cash for Bankers, Cash for Houses, Cash for Trash, and cash for every other blessed thing under heaven, the number crunchers were able to report positive economic growth for the third quarter.

Let's not get too excited. Stocks bounce. Bonds bounce. An economy bounces. Even dead economists bounce. And if we're following the Japanese experience, with a long, slow on-again/off-again period of depression, we can expect some quarters of growth, followed by quarters of non-growth. It's going to be a painful adjustment to the 'new normal,' whatever that is.

The other important bit of news was that the Fed - faced with undeniable evidence of growth and prosperity - decided to err on the side of caution. It will keep monetary policy loose from here until kingdom come, if necessary, in order to avoid a Japan-style slump.

But so far, a Japan-style slump is just what we seem to have...and our public officials are fighting it, Japan-style.

Unemployment is headed up. The U6 figure - a more accurate picture of how many people are out of work - is up to 17%. There are 1.5 million homeless children in the US now, including 300,000 in the state of California alone. One out of 10 Americans will not bite the hand of government - for it is the hand that gives him his food stamps.

Foreign direct investment has dropped 30%. International trade is down 10%.

Do you call this a recovery? We don't.

As David Rosenberg puts it, the man on the street is perhaps "less enthused by the fact that a lower rate of inventory de-stocking is arithmetically underpinning GDP growth at this time."

In other words, it's 'growth' that only an economist could love...and then, only an economist who was an idiot. Rosenberg:

"Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go - and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

"Only 29% of those polled believe the economy has hit bottom - imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally - not the onset of a new bull market) has not swayed their view (or ours for that matter). There is going to be some very tough slogging ahead as far as the economy is concerned."

Growth is largely illusional. It is the result of delusional policy- making at the Fed.

So, we'll just keep our Crash Alert flag flying.

Bill Bonner
for The Daily Reckoning Australia

• Markets Rise While the Economy Sinks
• Bear Market Bounce a Sure Thing
• Take Away Stimulus Spending and You’ve Got an Economy Entering Depression
• Come And Get It!
• AIG to Receive $85 Billion Loan from Fed

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

At $1,000, is gold cheap?

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

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

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

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

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

Bill Bonner
for The Daily Reckoning Australia

• Gold Not a Perfect Way of Measuring Wealth, Just the Best Way
• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• The Rally is On as the Dow Rises
• What Happens to Gold When High Inflation, Excess Cash, and Falling Dollar Jolts Economy?
• Does Gold Do Anything But Rise?

"US consumers are cutting back, and where they are not cutting back, they are scaling down. This new cycle is all about 'getting small' and it is deflationary. For yet another in the litany of signs pointing in the direction of social change towards thrift, have a look at what is transpiring at the upper echelons of the income strata - Now Even Millionaires See the Benefits of Budgeting on page B5 of the Saturday NYT is a must read.

"Not only are the rich trading down, but the article quotes a high net worth financial advisor who said 'many of our clients are very happy to be sitting on bond portfolios and cash reserves.' And see the article on page 2 of the Sunday NYT - Beauty Products Lose Some Appeal During Recession. According to the NPD Research Group, total sales of department store beauty products are down 7% from year-ago levels. Women are apparently opting for the 'natural look' - "some people are selectively replacing higher-priced items with cheaper products from drug stores and discount stores."

Right on, David!

And here's the CEO of Pepsico:

"The age of thrift is here."

Even in Japan, after 20 years of coughing and sneezing, people have caught "the thrift bug," says The New York Times.

What's a consumer economy need in order to keep growing?

Uh...it's needs consumer spending.

What do consumers need in order to boost spending?

Uh...they need more money!

Oh, there's where it all starts to come apart, doesn't it? Where do they get more money? They either earn it...or they borrow it. And right now, they can't earn it - not with 12% unemployment in California! Workers have no bargaining power. And they can't borrow it either. The banks won't lend - not with the value of their collateral still falling.

Word comes this morning that mortgage delinquencies have hit a new record. And here's a headline warning of worse to come:

"$30 billion home loan time bomb set for 2010."

Even solvent homeowners who aren't forced into foreclosure still find it beneficial to walk away from their houses. "Strategic defaults,' says The Los Angeles Times, are becoming a problem for mortgage lenders.

We didn't read the article. Instead, we began to think. What if we owned a house worth $200,000 with a $300,000 mortgage? What would be the smart thing to do? Easy...walk away from it. Then, buy it back at auction!

Desperate consumers do what they have to do. Canny consumers do what's smart. And now it's smart to walk away from any debt that you don't actually have to pay.

As for adding more debt, you can gage yourself from the comments above, consumers are not eager to borrow. They've seen what happens when they go too far into debt. They're older and wiser than they were in the bubble years. It's been 10 years since the tech bubble exploded. Since then, stock market investors have made nothing - zero. And now houses are falling too.

So, if a fellow needs money for his retirement, where is he going to get it? Not from his house. Not from a pay raise. And not from his stocks either. He needs savings. He needs real money.

Americans aren't so stupid after all. When they need to stop spending, they stop spending. When they need to save, they save. Too bad about the economy.

Yes, what is good for individuals seems to be bad for the economy. When people save instead of spend, the consumer economy stalls. And then economists think there is something wrong. They think an economy needs to expand constantly. And so, they try to find 'solutions' to the 'problem.'

Actually, there is no problem at all. It's just the way capitalism works. There are booms. And there are busts. Periods of growth...and periods when the mistakes made during the boom are corrected. There's a time for every purpose under heaven. That's the way it works. The economy breathes in and it breathes out.

And there's always some dumb economist trying to smother it with a pillow!

Bill Bonner
for The Daily Reckoning Australia

• Consumer Economy Not Going to Return to Robust Growth Anytime Soon
• The Percentage of the U.S. Economy Devoted to Consumer Spending Went Up and Up
• Two Ways to Deleverage an Economy
• America’s Consumer Economy Needs to Consume Less
• Don’t Bet on a Recovery

"The incoming economic data in both the US and Canada have improved and for the most part [are] bettering expectations. The dilemma is that market pricing has moved far beyond the fundamentals. Despite the temptation to jump into a 'liquidity-induced' rally...they cannot be sustained without a durable organic economic expansion. The problem is that the global economy in general, and the US economy in particular, is operating on so much medication that it is difficult to conduct an appropriate examination of the patient at the current time. All we know is that the markets seem to have very rapidly now priced in three years worth of recovery.

"The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation - usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs - during this extremely flashy move, the US has shed 2.5 million jobs (as many as were lost in the entire 2001 recession)."

The markets rise. The economy sinks. It is not sinking as fast as it was. But it is still going down. Month after month, the number of people without jobs increases. Even Paul Krugman says that unemployment won't reach its peak until 2011.

And house prices? Hard to tell what is going on. As Rosenberg puts it, this patient is so hyped up on drugs it's not possible to make a diagnosis. Still, he doesn't look good. There are millions of mortgages that still haven't been tested. Interest only...Alt A...commercial...even prime mortgages. They are facing reset...and refinancing...with collateral prices down 20-30-40%. How can you refinance when you are underwater?

Let's look at the basics. We had a nice thing going. From 1945-2007, consumer spending and credit increased. As long as lenders were willing to lend...and consumers were willing to go further into debt...the economy expanded.

Towards the end, it got a little crazy. And then it blew up.

As predicted, the feds rushed in to save the situation. But they only have one trick - adding more cash and credit. That works every time...until it stops working. And it stopped working in 2008.

Banks don't want to lend against falling house prices. And consumers don't want to borrow when their incomes are going down.

Ergo...the end of consumer credit expansion. Get over it.

But the feds keep at it. And with their help, the markets have bounced up. Of course, a bounce is one of the most reliable features of a market economy. A 50% bounce in the Dow - roughly equal to the bounce after '29 - would take the index to 10,300. We're not there yet.

So, there's nothing unusual or unexpected about this situation. The markets have done what they were supposed to do. The feds have done what they're supposed to do.

So what next?

Ah...dear reader...if only we knew the answer to that question...

Here we are in uncharted territory...terra incognito...

Never before has there been an international monetary system based purely on paper. And never before has it been run by people who believe they can force the market to do their bidding. They are convinced that they can avoid the Japan situation - where the economy dragged along for twenty years - by adding more cash and credit. Bernanke said he would drop it from helicopters if necessary.

Just one problem.... Bernanke can inflate...but only until the Chinese tell him to stop. When China pulls the plug on the bond market, the party comes to an end. That's why the helicopters are still on the ground. And it's why they will only take off when the situation becomes desperate.

In the meantime, we await the ordinary...that is, an ordinary end to a post-crash bounce. That will come with another crash. And another. And another. Until stocks finally hit bottom...and bubble-era delusions are finally all crushed out.

Bill Bonner
for The Daily Reckoning Australia

• The Economy is Getting Worse Not Better
• Gold, A Good Bet Against Bernanke & Co
• U.S. Economy is Still Growing but GDP Growth Rates Are Mostly Fraud
• Feds’ Plan is to Reflate the Economy
• Alan Greenspan Says “the Seeds of a Bottoming” Becoming Visible

..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
• How Does an Economy Expand When the Banks are Lending Less Money?
• 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

Alas, he did not fly. Nor even float. He fell "like a stone," the paper reported.

Immortality was achieved, but not the way he had hoped. His stunt was captured by the new motion picture technology of the time. That silent film inspired the very popular Jackass videos, which show people engaged in reckless acts of mischief and mortality.

But we do not have to go to Youtube to enjoy the Jackass genre. We have only to read the news. All over the world the authorities are strapping on their absurd parachutes...and climbing to very high places. In Europe, banks borrowed 442 billion euros last month from the European Central Bank. Much of it is lent back to European governments. In America, stimulus funds are used to fix public toilets, as well as to repair Wall Street's balance sheets. Trillions of dollars have been put at risk in these adventures - $23 trillion in the United States alone. And yet, despite the most daring experiment in stimulus ever, by the end of June, the British economy was 5.6% smaller than it had been a year before, paralleling the decline that followed the crash of '29. As for the United States...we await the figures...

On the evidence, stimulus programs aren't working. In fact, where they are tried the most they work the least. For proof, we go to Stimulation Nation itself. From America last week came news that new house sales had finally turned up. They were up 11% in June, according to the papers. That was the monthly figure. According to the annual numbers, they were down 21% from the year before - at the second lowest since they began counting in 1963. And since the population is much bigger than it was 52 years ago, this was relatively the worst June in history for new house sales. And now that the economy is in a slump, the rate of new household formation has been cut in half. Faced with lower incomes and worsening jobs prospects, people are less eager to set up new households - reducing the demand for new houses.

Unemployment shows no sign of improving, either. The stimulus program was supposed to cap joblessness at 8%. Officially, the rate is now 9.5%. Economist David Rosenberg puts the real unemployment rate almost twice that high. And businesses are cutting jobs even faster than expected. Economist Arthur Okun suggested a rule of thumb for predicting unemployment levels in a downturn. But firms are not only laying off redundant workers; they are laying off workers who would normally be spared. What's more, those who are left are working the shortest weeks ever recorded.

In the past, workers were quick to move to where the jobs were. The Sun Belt traditionally bounced back first. But Florida, California, Arizona and Nevada have been flattened even more than the rest of the nation - by record foreclosures, government cutbacks and bankruptcies. Now, the jobless stay put...and stay unemployed.

Currently, the excess capacity in the United States is staggering - both in labor and capital. Capacity utilization is only 65%; in theory, output can increase 35% before any new capital investments are made.

Recovery? "Forget it," says Rosenberg.

Now that the facts are out of the way, we end our critique of stimulus...and turn to laugh at the stimulators. "Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back," wrote John Maynard Keynes. And now it is Keynes' voice they hear.

"We are all Keynesians now," said Richard Nixon as he strapped on a crash helmet.

Keynes probably got the idea of a counter-cyclical stimulus in Bible class. And a good idea it was. Simple...intuitively correct...practically demonstrated...and theoretically sound. But he and his followers still managed to screw it up.

First, Keynes' General Theory is no theory at all...at least not in the scientific sense. It can't be tested. The results aren't reproducible. Instead, it's merely an idea about how things should work, based on an Old Testament story.

Pharaoh had a dream. He dreamt he saw seven fat cows devoured by seven scrawny, misbegotten cows. He didn't know what the dream meant, so he called for a young Hebrew man who had interpreted dreams for his master. Joseph told Pharaoh that Egypt was to enjoy seven years of abundance followed by seven years of famine. He told him what he should do about it too. He should store all the grain he could from the fat years...so he could pass it out when the going got tough.

This is a story we all know. It is easy to tell and easy to understand. But modern economists twisted it as though it were an inflation statistic. They maintain that when the business cycle turns down, it's just like a drought. And they can counteract the effect of the drought by giving the economy stimulus - liquidity - from the public sector.

Trouble is, they missed the point completely. Do you recall any public official urging the public to stop spending so much in the bubble years? Do you remember any Treasury Secretary or Fed Chairman suggesting that the U.S. government run real budget surpluses in the fat years? Does any headline from any paper in the nation mention a storeroom in which grain or treasure was stored for the lean years? Not at all! Instead, the feds encouraged people to eat their grain! Governments ran deficits even during the bubble years, with the biggest deficit in history in 2008, just as the lean years began. Now they have no real grain to offer. So they turn to a reckless, disaster-defying stunt - passing out phony money, like sawdust muffins...

Future generations will watch the video and laugh until their stomachs hurt.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• US Federal Government Ran the Biggest Deficit in History
• Government Stimulus Programs Make Life Harder For Banks
• The Dead Weight Cost of the Stimulus
• Economists Agreed the Stimulus Was Working and the Recession Was Coming to an End
• Public Works Done Right

The bear market rally, that is? The Dow was down again yesterday...but just a little...52 points.

The short-covering rally is finished, says David Rosenberg, formerly one of Merrill's top analysts.

"Everyone I know is laying people off...cutting back...and generally struggling to survive," said a colleague from Florida. "I don't believe this recovery story. The stock market might be up, but the real economy is still sinking."

Yesterday, we went to get our teeth checked out.

"Hey...I'm a Daily Reckoning reader," said our dentist. "So, I knew you were in town."

Asked about the state of the economy, he had this comment:

"Our business is a little counter-cyclical. People get laid off from work, but they still have their health benefits - at least for a while. They want to make use of them while they can. And they've got the time to do it. So, our business actually goes up.

"But then, when the recovery comes they go back to work...they're busy...and they've already had their teeth fixed. We're not seeing that yet."

House prices are still falling. The average house in Southern California has fallen to $247,000 - a big drop from the top set two years ago. Toll Bros., one of the country's biggest builders, reports revenues down 51%.

If the US economy is really following Japan, things are going to get a lot worse. Japan's output is collapsing - at a 15% annual rate last quarter. The Land of the Rising Sun is a major exporter. For the first time ever, exports are falling...taking the Japanese economy down with it.

Internally, the Japanese are still not big spenders. The population is not only aging...it's shrinking. That's not happening in the United States. Thanks largely to its immigrants and Hispanics, the US population is expanding. But this new population is not the same as the old one. At the top of the socio-economic pyramid in the United States is a huge group of aging, mostly white baby boomers. Naturally, the geezers vote. And naturally, they vote themselves more benefits at the expense of the next generation.

In fact, you can look at the entire bailout/stimulus program...and the $1.8 trillion US budget deficit for 2009...as a huge transfer of wealth. Benefits are provided to the present generation at the expense of the next generation. The white boomers borrow - through their elected federal representatives. The next generation - much more Hispanic and much more immigrant - is stuck with the bill.

But it's not that simple.

The bailout/stimulus program is a scam on top of a scam. One generation may be trying to get something at the expense of the next - but they're both losing. On the surface, the next generation gets stuck with the cost of bailing out the present generation. But underneath, the bailout is a sham; it doesn't really work. It doesn't revive the economy. All it does is move money from sensible households and good businesses to reckless spenders, mis-managed firms, and foolish projects. The losers are the winners.

What it doesn't do is bring about a general recovery in the economy. It can't - for all the many reasons we've described in these Daily Reckonings.

The feds can spend money. But they can't turn bad investments into good ones...nor turn hopeless, brain-dead companies into successful ones...nor erase $20 trillion of excess debt.

All the feds can do, in other words, is make a bad situation worse.

First, they mislead investors into believing the fix is in. With all that money coming into the market, people think the problems are going away. "Everything is under control," they say to themselves. Then, they put their money into stocks, deluding themselves that a new boom is underway. Later, when it becomes clear that the boom is a long way off, they are deeply disappointed. Stocks fall...and the economy enters a long, dark period of workouts, defaults, bankruptcies, disgrace and suicides.

Then, as we have explained many times, the feds' money actually delays the process of creative destruction. Instead of burning off the dead wood and making room for new growth, the smoke jumpers at the Fed parachute out of airplanes to smother the flames. Instead of a hot fire that burns itself out in 24 months...the economy suffers a slow burn for 10 years.

Another way they make the situation worse is by undermining the rule of law and the predictability of economic rules. When a corporation goes broke BOTH the bondholders and the stockholders should suffer. But in bumbles the Federal government with bailout money. The share price plummets as investors anticipate a clumsy takeover - wiping out the shareholders. But the bonds could even go up - as the firm is given easy credit, allowing it to stay out of bankruptcy and continue paying off the bondholders.

Worse, as in the case of the Chrysler bailout, the feds jumped in and upset everybody. Instead of letting the markets sort out the stockholders and bondholders, they forced a political settlement that rewarded one class and punished another. Bondholders got less than they should have...and the autoworkers union got more.

What is this? A free-market country with the rule of law? Or a third- world basket case in which the politicians decide who gets what?

Bill Bonner
for The Daily Reckoning Australia

• No Evidence of Recovery as Unemployment Getting Worse
• The Economy is Getting Worse Not Better
• Depending on the Landlord
• If the Economy is Not Recovering It Isn’t Getting Enough Stimulus
• Boomers Made a Mess of the United States of America