Yes, dear reader, even our heroine, Angela Merkel, is joining the fools' parade. In a front-page feature in yesterday's International Herald Tribune we learn that Ms. Merkel is bringing Germany in line with the rest of the world - by increasing the public deficit to over 6% of GDP.

"Germany chooses growth over paying debt," says the misleading headline.

But 6% is only half the US level...and the UK is nearing 15%!

The raw news: the Dow fell 93 points yesterday. Gold held above $1,100. There's no sign of panic. But we keep our Crash Alert flag flying anyway; you never know.

We're in Rome...actually in the airport...on our way back to London. Alitalia offered the best deal to Buenos Aires. But the plane was a disappointment. The food was good; the hostesses were pretty; but the seats in business class didn't fully recline. After the first 10 hours, we were very uncomfortable. And pity the poor folks in economy!

But if you want to be an "international man," as our friend Doug Casey termed it, you have put up with some inconvenience. Why would you want to be an "international man?" As another old friend, Marc Faber, observes, it pays to travel. You get a broader perspective. And you realize that many things your compatriots take for granted others take for absurd. "The more you look, the more you see," is our dictum.

One thing Americans take for granted is that they will always be the richest, most successful people on earth. They think that because that is what they have always known. The US economy became the biggest in the world before 1900. Americans had just what it took to become the richest people on the planet. They worked hard. They saved their money. They had little government interference. They had the industrial revolution at their backs...and nothing in their way. And they had a dollar that was 'as good as gold.' By the time the baby boomers were born the US had such a big lead over the rest of the world, it seemed like nothing could stop it. Free enterprise guaranteed new innovations and new wealth. Democracy guaranteed a political system that would adapt to the needs of the evolving economy.

But nothing lasts forever. As it matured, the US economy and its political system became more and more rigid and more and more costly, with handouts and bailouts...at every level. Large companies are protected. Millions of people are encouraged not to work. The whole financial industry is dipped in honey. And the whole population is urged not to save, but to spend. Why bother to save for retirement; there's Social Security. Why bother to save for health care emergencies; there's the government's new overhaul of the medical system! Why bother to save at all; the government has fixed short-term rates so low you get nothing for your trouble.

On our travels what we notice is that there are a lot of smart people in the world. And they're all sweating, striving, and angling to get ahead. You never know who will win the race, but you can be sure that no one will stay in the lead forever.

"US Wages Out of Balance," says The New York Times. It is pointing out the obvious. Americans are paid too much, compared to other people in the world who work just as hard and who now - thanks largely to the feds - have as much or more capital than we do.

Wages in the US will come down - probably thanks to unemployment and inflation. So will US living standards compared to the rest of the world.

Meanwhile...back to Angela...

Generations of German central bankers learned their lesson. They saw what happened when hyperinflation ran wild in the '20s. The middle class was wiped out in a matter of days. People lost faith, not only in the Deutsche Mark, but in Germany itself...and in all the old values. The next thing they knew, the Chancellor was wearing a silly uniform and they were on the road to Hell.

More recently, the last generation of German central bankers worried about the euro. They had no doubt about themselves. They had the backbone to protect their new currency. But what about the Italians? And the Greeks? And the Irish?

Well, they can fret no more. Now, the German deficit is higher than the Italian deficit.

Why would they do such a thing? They have the usual poppycock explanations - countercyclical spending, the need to maintain social services as tax revenues fall, the need to bailout the East, (see below) etc. But the real reason is that the old German economists are dead. One of the last of them was our colleague Kurt Richebächer.

Every time we saw him, Kurt would complain about American and English economists.

"Ya...you Anglo-Saxon economists are ruining the world," he would say. Kurt had no truck with Keynesianism. Or monetarism. Or any other of the fads in economics. Besides, he had lived through Germany's hyperinflation, the rise of National Socialism, WWII, partition, and finally, reunion. He knew that there were no free lunches...no easy fixes...and no panaceas. He knew too that people who promised miracles were dangerous frauds. Wealth is created by work...saving...innovation...investment...and perseverance. There are no miracles. No short cuts.

While wealth is created by work and saving, it is destroyed by consumption and debt. When you borrow money, you have to pay it back. Then, you must draw down your wealth...reduce your living standard...and cut into the capital you laid away in years past. You can try to squirm and dodge...but you just make the situation worse.

Kurt was right.

But now Kurt is dead. A new generation of economists has taken over. Born after the war, they know hard times only from movies and history books. They haven't forgotten the old truths; they never learned them. Instead, they probably did their training at Harvard or Chicago...and studied nonsense...such as the Efficient Market Hypothesis and Modern Portfolio Theory.

They think the key to prosperity is spending. Consumers spend until they can't go on. Then it's up to the government. That's why the Germans are running such a high deficit. The think they need to keep up spending - at all costs - in order to boost the economy. As Kurt used to point out, it makes no sense theoretically...and there's no evidence that it works in practice either. Every time governments have intervened with large dollops of countercyclical spending they have made a mess of things...either by stimulating the private sector to further acts of reckless insolvency...or by blocking the process of correction.

It's all claptrap. Angela, you should be ashamed of yourself.

Bill Bonner
for The Daily Reckoning Australia

• The Greatness of a Depression is Commensurate to the Government’s Efforts to Prevent It
• French Model of Economy Allows Meddling from the State
• Ben Bernanke “Respectfully Disagreed” With Angela Merkel
• The French are Feeling Pretty Smug
• Pension System: A Conversation With Chile’s Former Labor Minister

We did some thinking yesterday, on our trip to Uruguay. Why Uruguay? We thought we should have a look around. Montevideo is a cheap place to live. It's on the sea, with beaches near the downtown area. It is an old town, with many fine buildings. It is clean. It is safe. It has history too. When the English invaded Buenos Aires, the Spaniards launched a counterattack from the fortress at Montevideo and got it back.

"It looks like a nice place," we said to our local contact. "But it seems a little like a resort town out of season; it's very quiet."

We were having dinner in the best restaurant in town, next to the opera house. The restaurant was large and well fitted out. But it was almost empty. A French group sat at one table. An American group sat at another. The only other diners were sitting with your editor. Outside on the street, it was as if everyone else had been warned of an approaching tsunami; there was no one.

"Well, it's out of season all year round," our host replied. "It's a nice place to live. But it's not very lively.

"Montevideo used to be a lot richer. You can tell that just by looking at the public buildings. They're very grand. We couldn't build those places today. We don't have the money. But during the war years, Uruguay was booming. We were leading exporters of beef and grains. We're still leading exporters...but the margins are no longer there. You can make money in farming, but not enough to get rich."

We wonder what people are going to be saying a century from now.

"Yeah, Manhattan used to have the richest real estate in America...back in the financial boom. Wall Street was the center of the financial industry. People made fortunes from high-margin financial products. But then, the financial industry went into decline...and new financial centers in Shanghai and Singapore took the business."

Could New York have already passed its peak? Perhaps not quite. The papers are reporting record bonuses on Wall Street. But the story has an undertone of desperation about it...like the wild parties in Berlin in 1945, just before the Soviet Army arrived. Maybe that's why the bonuses are so high. Get it while you can! This could be the last hurrah for the US financial industry.

Private sector credit is still contracting. In fact, it's shrinking faster than at any time in the last 35 years. And this trend is not likely to change. As we keep saying - you're probably getting tired of hearing it - the private sector has 7 to 15 years of de-leveraging to do. The financial industry will be forced to downsize, along with the economy.

Wall Street's leveraged debt bombs are still blowing up. Banks are going under. As we reported yesterday, the 'second wave' of residential mortgage defaults may be just beginning. Commercial real estate debt isn't far behind...with no Fannie Mae to help the wounded or pick up the dead.

And how about all those private equity deals Wall Street financed? Of the top 10 deals from the bubble years, 6 are in trouble...and 4 have already defaulted.

The idea of private equity was that the hotshots were so smart they could take over a company, re-organize it, restructure it, and sell it back to the public market at a higher price. What they actually did was merely to load up the company with debt - using the money to pay themselves lavish fees.

And as we know...and maybe we alone know it...debt hurts. Run up enough debt and sooner or later bad things will happen. But not necessarily to the borrower!

Right now, the dollar is at a 15-month low. The speculators borrow dollars. Then, it doesn't matter what they do with them. Everything is going up against the greenback.

But that's why our Crash Alert flag is flying. Mr. Market doesn't like it when morons make money. We wouldn't be at all surprised to see these carry trades go bad in a big, big way. All of a sudden, stocks...bonds...emerging markets...commodities...and even gold...could go down against the dollar. Watch out!

The Dow rose another 20 points yesterday. It is now only 54 points below the 50% retracement level...where the bounce of 1930 peaked out.

Gold, meanwhile, held above $1,100.

As we were saying...once in a while, we think. The last few days have been so busy, we didn't have any time to think. But, now things are settling down, so we've had a chance to put our thinking cap on.

What are we thinking about?

Well, of course, we're trying to understand the basics... George Soros had the right idea: Find the story whose premise is false...and bet against it. What premise is false?

The major premise that almost everyone believes is that government economists can improve the workings of an otherwise free economy. That leads people to believe that the feds have pulled off a save...they've now got the economy well along on the road to recovery...the recovery is getting stronger as time goes by...and soon, the feds will begin to exit from their stimulus efforts.

The big question in most investors' minds is this: how quickly will the feds exit? As long as they keep up their stimulus efforts, investors expect rising prices for everything but the dollar.

Those who think the feds will be able to exit quickly believe growth will come without too much inflation. Those who think the exit will come slowly expect higher rates of inflation.

Well, guess what? The whole premise is false. From top to bottom. From beginning to end. Even the air it breathes is tainted with the smell of fraud and self-delusion.

The theory behind the recovery concept is that government spending and stimulus from the Fed has a "multiplier" effect. That is, the feds spend...the money goes into the economy...and then, the private economy multiplies the spending by growth in consumption and investment of its own. If there were no multiplier effect the whole exercise would be a waste of time, because we know that government spending in itself is a cost to an economy, not a source of real wealth. Government spending, generally, is a drag on prosperity. The Soviet Union proved that. The question remains however, can extra government spending at critical moments "prime the pump" so that it is multiplied by the private sector?

Answer: no.

"Our new research," writes economist Robert Barro in The Wall Street Journal, "shows no evidence of a Keynesian 'multiplier' effect...the available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise the GDP by less than the increase in government spending."

Now, we turn to the current situation. Is there any evidence of growth beyond the government's own stimulus efforts? From what we can see so far, again, the answer is 'no.'

The premise of recovery/multipliers/growth/and exit is false. We want to bet against it. Tomorrow we'll talk about how.

Real economists know that there are no secrets. You work hard. You invest carefully. You save your money. That's the best you can do. There are no multipliers. There are no miracle cures. There are no easy exits from trouble.

That's why the world has little use for honest economists; they tell you what you don't want to hear. So, people turn to the phonies...the charlatans...the imposter economists who say "yes we can!"

Trouble is, they can't.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Government Debt
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• Why Weren’t Economists On Top of This Thing?
• Can Government Bureaucrats do a Better Job of Allocating Capital than Free Markets?
• Have the Feds Given the Economy a Miracle Drug?

Australian baby boomers have never experienced a "rainy day" - so they've never planned for one.

But then why would you?

Over the last 20 years, virtually everything has gone up... and up...

A generational bull market has lifted the stock market, property values and commodity prices to dizzying heights. Most of us have felt the benefit of this in some way or other.

It's certainly made us feel a lot wealthier than we are. And when you feel wealthy, you tend to act wealthy.

And that's just what we've been doing - in some style... We've bought bigger houses, newer cars, nicer TV sets - and in the process, we've racked up more personal debt than the Americans were in just before the U.S. sub-prime crisis hit.

How deep in debt are we?

According to the Bank of International Settlements (BIS), during the 1980s, the ratio of household debt to disposable income for Australian households was around 45%. For every dollar an Aussie earned he owed 45 cents. Not ideal - but manageable.

Since 1990, the BIS reports that this ratio has risen rapidly, reaching an incredible 157% in December 2007. That means for every dollar the average Aussie earns, he owes $1.57.

In an October 2008 article, The Australian reported:

"By 2008, Australian households carried 35 per cent more debt relative to their income than Americans. The great Australian middle class has become more addicted to credit and more spendthrift than the US, the home of consumer capitalism."

We all know what happened in America after their debt bubble exploded...

But despite that warning, and despite debt far in excess of their incomes, Aussies are STILL spending money like it's going out of fashion.

In June 2009 the government handed out $900-a-piece to low and middle-income earners as part of a $23 billion stimulus package. By August, Australian National University economist Professor Andrew Leigh found that 40 per cent of those who'd received that cash had spent the lot. That's some stimulus for the economy!

"This is approximately twice as high as the share of United States residents who reported that they spent the tax rebates handed out in 2001 and 2008," noted Professor Leigh.

We all love spending free cash - who doesn't? - But every dollar you fritter away now is a dollar your future self will have to find when there's no regular money coming in.

The fact is, despite the overwhelming warnings, many of us spend more than we earn without any thought to the consequences... we believe that house prices will always rise... that high asset values equate to "true" wealth... and that we don't have to save any of our income because our super will provide us with a comfortable retirement.

But hang on a second - How often do you audit your super?

How regularly do you check to see whether your nest egg is still growing... or, at the very least, well protected against the economic downturn? Every month? Once a year? Never?

Have you checked it recently? Maybe you should...

Many Aussies opt for their company approved super fund and then forget about it, expecting to be handed a huge cheque at the end of their working life.

Granted, it's convenient: no research, no hassle, no worries. There's usually a big name behind the fund, and the glossy brochure your HR Manager hands you makes you feel cosseted and reassured.

It's the easy choice so you take it. And you stick with it - because you never physically see the money... it's just another deduction on your pay slip. It's not as if you're actually handing over piles of notes to someone to safeguard and nurture for you.

According to a recent report by superannuation research firm Chant West, the majority of retail super funds (i.e. yours) are classed as "growth" funds; defined as containing between 61 and 80 per cent of their allocation in assets such as shares. Even if you're invested primarily in a "balanced" fund, 40-61 per cent of your retirement cash will still be held in "growth" assets, says Chant West.

Growth assets are great when the market is going UP... but you want to limit your exposure to these assets when the market goes DOWN. And that's the problem: in the same report Chant West states that the average 'growth' super fund fell by 13% in 2008/09.

This is the worst return since the introduction of compulsory superannuation in 1992.

The worst return in the history of super.

That's a real kick in the teeth.

And the thing is, unless you've been paying attention, you may not have even noticed it. Rest assured, it'll smart pretty badly when you're still doing that early morning commute five... or even ten years after you'd planned to retire.

Please understand: sticking with the 'default option' of your company super allows someone you don't know to make all the crucial decisions that affect your financial future.

In terms of committing crimes against your future self, this is just about the worst thing you can do. Believe me - you may as well jump forward in time to the day you retire and punch yourself square in the face.

Kris Sayce
for The Daily Reckoning Australia

• Your Average Australian Super Fund
• World of Super Collides With World of Credit Crunch
• Is Kevin Rudd Planning to Steal Your Superannuation and Bankrupt Your Retirement?
• European Governments of the Eurozone are Separately Responsible for Their Euro-debt
• Your Actively Managed Superannuation Fund Cannot Beat the Market

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

• Baby Boomers Face Early Retirement With No Money Saved
• Feds Want to Increase the Money Supply and Induce People to Spend Money
• No Evidence of Recovery as Unemployment Getting Worse
• Have the Feds Given the Economy a Miracle Drug?
• Bankers Betting That the Money Given by Feds Will Be Worth Less Next Year

The credit crisis seems to have exploded the traditional equilibrium between cash and debt. Of course, this "equilibrium" was no such thing, as corporate cash levels have been perilously low for years...at least in the finance sector.

But corporate chieftains are becoming attentive to danger, at least for now.

"The credit crisis seems to have put fear back in their spines," Chris remarks. "The 500 largest US companies - excluding financial firms - hold the largest cash hoard as a percentage of assets since 1960. The Wall Street Journal reports today that cash hoard is nearly $1 trillion, or about 10% of total assets. That was in the second quarter, for which we have full numbers. So far in the third quarter - with 248 of the 500 firms reporting - cash has increased to 11.1% of assets.

"Cash is the financial equivalent of a big, soft pillow," Chris continues. "It helps you sleep better at night. After the credit crisis turned small balance sheet leaks into lethal holes, executive suites around the country seem determined not to let that happen again. The Wall Street Journal highlights the case of Alcoa, the big aluminum producer. It sits on $1.1 billion in cash, up 28% from a year earlier. It cut its dividend, even though it is making money. The CFO said, 'We're just going to be extremely prudent.'

"But there might be another reason why the bigwigs sit on all that cash," Chris reasons. "They might just not see many good opportunities to invest in right now. In other words, the piling up of cash in America's corporate treasuries may just mirror the weak economy."

But Chris suspects these corporations won't pile up cash forever. Eventually, they will start itching to launch takeover deals. In fact, Chris points out, "We are already seeing a pickup in takeovers and mergers. Just last week, CF Industries, the fertilizer company, upped its bid for rival Terra Industries. The new offer is worth $200 million more and is mostly cash. Also last week, Denbury Resources offered $50 per share for Encore Acquisition - about $15 in cash and the rest in stock."

So even though the overall market seems richly priced at current levels, Chris has been setting his sights on a handful of names that look to him like ideal takeover candidates. T3 Energy Services is one of his favorites. He believes this leading oilfield services company would make a good fit with the likes of National Oilwell Varco or Cameron Intl.

Tesco (TESO:nasdaq) would be another juicy target, Chris believes. The stock trades slightly below book value, only 11 times earnings, and also has a clean balance sheet. In today's edition of The Daily Reckoning, Chris provides a few other scintillating details about Tesco.

Eric Fry
for The Daily Reckoning Australia

• Tesco is a Buy
• Level 3 Assets Growing in All Five U.S. Investment Banks
• Equity Premium Will Be Replaced With a Tangible Asset Premium
• You Can Never Be Sure How Fabricated Income and Earnings Are These Days
• A Trader’s Market or an Investor’s Market?

There are some pretty big issues we left hanging with yesterday's DR. Are the Western Welfare States (the U.S., Japan, and EU nations) really going bankrupt? Things were headed that way before the credit crisis began. If Rogoff and Ferguson are right and the GFC is becoming a sovereign debt crisis, it will worsen an already bad situation.

How bad? We'll show you three of the charts we showed the folks in Canberra on Sunday. This is the condensed version of a forty-five minute presentation. So we'll have to leave out the colour commentary. And we're pleased to offer another contribution from Dr. Steve Kates on how government policy is destroying public wealth.

But first, check out the chart below from the 2008 annual budget audit by the U.S. Government Accountability Office. It shows that the U.S. government must roll over $3.4 trillion in debt over the next four years. This $3.4 trillion does not include any additional borrowing that may be required for other government programs (wars, healthcare, wars, school lunches).

What's the big deal? $3.4 trillion is a small number by today's standards, isn't it? Not exactly.

The chart shows how incredibly interest-rate sensitive U.S. government borrowing now is. Not only is it a big ask to ask the world's creditors to continue funding such large deficits (there are only so many savings available to borrow, after all), but the interest expense on that debt is likely to go up as the fiscal position of America deteriorates.

And if America can't find anyone willing to finance its deficits, what then? Well, the luxury of issuing debts in the currency you also print is that you can print money to pay for them. Technically, you can never become insolvent when you enjoy this privilege. The Fed, for example, can create new money to buy debt issued by the Treasury, funding deficits ad infinitum.

But this monetisation of the debt is another way of saying that international creditors are no longer willing to pick up America's spending tab. They will be betting against the American economy, not on it. Even if the Fed takes the unusual step of moving out further along on the yield curve to set interest rates (and keep the bond vigilantes from sending yields to the moon) this is a clear signal to owners of dollar-denominated assets and holders of dollar currency reserves to get out.

Another scenario to watch for is when creditors begin asking the U.S. to issue debts in currencies other than its own (Yuan, Euros). That would be something. In the meantime, they will look to lessen their dollar reserves.

That may not be such an orderly process. And the urgency to get out of the greenback and into something better will only pick up pace as it becomes clear the politicians in America (along with the Fed) are not likely to suddenly rediscover fiscal prudence.

You never know. The Fed may assert its independence and baulk at more quantitative easing. But we wouldn't count on it. And we reckon tangible assets and possibly emerging market equities would be the biggest beneficiaries of capital flows out of the dollar...and into anything else.

The next chart is for you, Paul Krugman. Krugman, among others, continues to insist that larger public sector deficits are necessary if the Western world is to avoid a Japanese-style deflationary "Lost Decade." He claims the government must increase spending as households and businesses deleverage and reduce debts.

Advocates of this idea claim that public sector deficits, as a percentage of GDP, have no real limits. And the example they cite is Japan. As you can see from the chart below, Japan's debt to GDP ratio is nearing 200%. America's isn't even half of that yet (it's about 98%, or $13 trillion). If Japan can finance a deficit at 200% of GDP, then why are we worried that U.S. deficits half that size would threaten interest rates or the dollar?

First off, it's worth pointing out that high public sector-debt-to GDP ratios haven't worked in Japan, if by work you mean pave the way to a stable recovery. Advocates might say-as advocates of the stimulus here in Australia often say-that the public spending made things less worse. But the opposite is true. It's made things more bad!

Or just worse, if you prefer. We mean that the public spending has done two things, neither of which is productive, and both of which, in fact, waste capital and resources. First, public sector spending to prop up financial firms with dodgy assets prevents the needed reckoning in asset prices that would produce market clearing prices for commercial and residential real estate. You get zombie banks and a zombie economy and zombie house prices.

Secondly, there's no indication that all the infrastructure spending in Japan has produced any kind of lasting growth for the economy. It may have built some great roads and bridges. But we wonder if it solved any of the underlying problems? What' more, the capital and resources that went into those projects was directed by political considerations and not available for the private sector, which could have put them to some use at least designed to produce a return on the capital.

The underlying problem which deficit spending does not solve is compounded by demographics. Japan's government is hoping that continued borrowing can be financed at low rates by pensioners who will be cashing out of their pensions but seeking safety. However, we suspect that Japanese pensioners will begin to consume their savings as they downsize their lives into their twilight years (which tend to last much longer in Japan, as the number of Japanese centenarians shows).

That means interest on Japanese bonds-which already one fifth of the Japanese budget-will consume even more of the nation's resources, if the older population clams up with its money. And like in the U.S., you'll see the government borrowing more and more of every new yen spent, with more of that borrowed yen going to pay a previous creditor. That's bordering on Ponzidom.

Japan has been able to run a higher-than-average public debt-to-GDP ratio because it has had such a high personal savings rates. This kept borrowing costs low for the government. But we'd expect that to change soon. A debt-to-GDP ratio of 200% will be very difficult to finance in the world as it is-much less in a world where those rates begin to rise and when Japanese savers begin to consume their savings.

Finally, what about Europe? Our argument here is simple: Europe's monetary union is going to come unstuck. Why? Europe has one interest rate for twelve different economies. That does not leave national governments with the flexibility to print money and inflate away political problems. This will be intolerable, the monetary union will break up.

The sign to watch for is a spike in the yields on euro-denominated debt. As the chart below (from Stratfor) shows, earlier this year bond yields did in fact begin to widen. Germany Bunds have the most stable rates, as Germany has traditionally the most stable fiscal and monetary policies in Europe (they did not go hog wild for stimulus).

But for Spain, Ireland, Greece, Portugal, Italy and Austria (whose banks lent large for real estate in Eastern Europe), another round of falling asset values really would show that the GFC has become a sovereign debt crisis. And will Germany bail out these nations? Can it afford to?

We don't know the answer to those questions. But it is worth pointing out that by assuming or guaranteeing the liabilities of the financial sector, national governments have also assumed the risk. And the bond markets will be left to decide how to price this risk.

How it ends is anyone's guess. But our take is that the Super Cycle in fiat money is at its peak. And as it unwinds, it's going to take national governments and their financing model with it. They will be forced to adopt a new model and take a new form to survive.

This means a great deal of political and economic upheaval. It's no coincidence that the last time the world faced such monetary upheaval was when it went off the gold standard and straight into essentially thirty two years of military and economic conflict (1913-1945). If the world is about to become that disordered again, you'll need a plan to deal with it.

Dan Denning
for The Daily Reckoning Australia

• Japan and its Economy Did Not Have Secret to Everlasting Success
• Government Debt
• U.S. Treasury Auctioning Off $81 Billion in New Debt
• Zero Percent Interest Rate Didn’t Work for the Japanese
• AIG to Receive $85 Billion Loan from Fed

Our views are different, but not extra-terrestrial. Once upon a time, not so long ago, they were even respectable. The gist of our message two weeks ago was that debt is dangerous. It feels good at first. But give a society too much debt - either in its private sector or the public sphere - and someone's going to get killed. That's why the present situation is such a delight to serious economists; it offers more data points. We get to see how much straw the feds can add before the poor camel's back breaks.

What's the best way to get through a debt crisis? Straight through was our advice last week. For at least a thousand years, the business cycle went round and round without help from central bankers or economists. It is only since these geniuses have been on the case that really serious problems have arisen. The Panic of 1920 - in which the US government did nothing but cut taxes and spending - was quickly forgotten. The Panic of 1929, on the other hand, was followed by massive rigging and jiving by the authorities. It took 20 years and a world war to overcome; today it is still remembered today as the Great Depression.

Martin Wolf, speaking, gravely, for the world's intelligentsia in The Financial Times last week, proclaimed that: "the only thing worse than rescuing the system would have been not rescuing it." But he is wrong; of all the many blessings economists may bestow upon a grateful people, improving the economy is not one of them. An economy is a natural thing. It can be improved by the striving of entrepreneurs, the prudence of bankers, and the sweating of field hands. But when it comes to the macro-economic policy, forbearance is the quality that pays. Any initiative on the feds' part inevitably makes things worse.

The Bubble Era, like the Great Depression, was largely -but not completely - the result of government initiative. Artificially low interest rates - intended to counter the modest downturn of 2001 - sent the wrong message. Consumers - notably those in Britain and America - bought things they couldn't afford. Producers - notably those in Asia - made things for which there was no real market. Debt piled up. Mountains of it.

As consumers bought more and producers made more the economy grew. But much of the economic "growth" of the 2001-2007 period was fraudulent. It was based on debt spending, not on genuine increases in purchasing power. Debt pretends to be real money. It looks like the real thing, but it is not. It stimulates the economy like counterfeit money. It causes production and consumption, but of the wrong sort. Former Reagan era Office of Management and Budget director David Stockman estimates the level of "counterfeit GDP" at $4 trillion in the US alone.

The fraud was discovered, though misunderstood, when sub-prime debt began to implode. The economy had been kissed hard; millions of houses had been built, bought and sold. Now, owners couldn't pay for them. All of sudden, the counterfeit money began to shrivel up. Lenders, investors, and householders all began to de-leverage; paying down the debts as fast as they could, defaulting on those they couldn't.

Rather than come to the obvious conclusion, that they should never have meddled with the economy in the first place, the feds began rescue operations on a breathtaking scale. The British government increased spending to 140% of revenues. America now runs a stimulus program nearly equivalent, in economic impact, to WWII. Not since 1945 have the two pages of its ledgers - debits and credits - told such different stories, with almost $2 of spending for ever $1 in tax receipts. Britain will add almost 50% to its government debt in the next three years. David Stockman expects the publicly held US national debt to almost double in the next five years.

Even at those levels, many economists think the government should do more. Nobel Prize winner, Paul Krugman is one. Richard Koo is another. They've warned that the US (and by extension much of the rest of the world) could suffer a Lost Decade, like Japan, if the government slacks off before consumers have finished de-leveraging. At least they understand what is going on. Too bad they missed the point of it. The problem is too much debt, not too little spending. Leveraging up the public sector doesn't help. Even government debts must be paid - if not by the borrower, then by the lender. The feds are smooching more ardently than any debt lover in history; next, we get to see who dies...or at least who defaults.

Until next time,

Bill Bonner,
for The Daily Reckoning Australia

• Why Weren’t Economists On Top of This Thing?
• Where Do the Feds Get Any Money?
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• US Economy Still on Runway as Recovery Won’t Fly
• Cash is Created When the Feds “Monetize the Debt” by Buying US Treasury Bonds

Another national emergency! Terrorism...the banking crisis...now Swine Flu.

Why it is an emergency, we don't know. Our sister, living in Virginia tells us that several of her grandchildren have come down with the Swine Flu. It doesn't seem to bother them anymore than any other flu.

But every emergency is an opportunity. The feds don't want to waste it. Instead, they swing into operation with a rescue plan. It will end up costing billions...hundreds of billions...or maybe even trillions. We don't know what they've got in mind. But we know what will come of it. It will end up extending the power and influence of the government. So far, the feds are the only real winners from any of these crises. Federal outlays, as a percentage of GDP have shot up from less than 20% of GDP in 2000 to more than 26% in 2009.

Will it do any good? Public health is not central banking. And it's not economic planning. Force everyone to wear a surgical mask and maybe lives would be spared. Or, maybe not. Without the immunity of occasional bouts of flu, who knows? Maybe people would be more susceptible to the next disease. The American Indians were almost wiped out...because they had no immunity to European diseases.

Interesting...

Ain't nature amazing? Disease works like an economic correction. It winnows out the weak...and it toughens up survivors. Allowing people to get sick is a little like allowing them to go broke. It keeps the whole system from softening up...from becoming more vulnerable. It protects people from moral and biological hazard. In other words, it's the correction that really provides protection...the disease itself, not the cure. Or, to put it another way, it's the crash that is beneficial, not the rescue.

David Einhorn, one of the few people to make money in the crash of sub-prime debt:

"The financial reform on the table is analogous to our response to airline terrorism by frisking grandma and taking away everyone's shampoo. It gives the appearance of 'doing something' and adds to our bureaucracy without really making anything safer."

The Wall Street Journal reports that even bankruptcy can be a good thing. "Household Debt Can Hasten Recovery...when it goes unpaid," says a headline.

The whole idea of a correction is to wash out mistakes. If people can pay their debts down, the mistakes are corrected. The system is strengthened. If they can't, the process of correction can happen faster. Bad debts are written off quickly. Then, a real recovery can begin. Either way, the system comes back in better shape.

Too bad the feds are getting in the way!

A decent correction should carry off those who made the biggest mistakes - in the present case, the firms on Wall Street that wagered billions on a bigger and bigger bubble. But instead of letting them go broke, the feds rewarded them.

Wall Street profits are a 'gift' from the state, says George Soros.

But wait, what kind of gift is this? If you give $100 to your neighbor, that's a gift. But what if you tax your neighbor on the left $100 in order to give the money to your neighbor on the right? That's a gift too...but of a special kind. You're 'redistributing the wealth,' you might say.

And what if you do a quantitative easing? You know, you print up a $100 bill and give it to your neighbor? That's a gift too.

Yeah, thanks a lot.

Meanwhile, the recession is said to have come to an end in the US. GDP growth is positive, say the papers. But if this is a recovery, let's hope it comes to an end soon.

Existing house prices continued to fall in September.

Unemployment continued to worsen. "Signs of recovery don't extend to jobs," says the WSJ.

Bill Bonner
for The Daily Reckoning Australia

• Naturally the Feds Want to Raise as Much Money as They Can
• The Fed Cut Rates – But How Low Will They Go?
• Feds Buy Houses
• Feds Have Used the Correction to Increase Their Power and Add to Their Wealth
• AIG to Receive $85 Billion Loan from Fed

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Yep.

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

Yep.

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

Yep.

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

Bingo!

How does the public sector deleverage?

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

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

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

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

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

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

Until then,

Bill Bonner
for The Daily Reckoning Australia

• Bankers Take Money From the Government and Use it to Speculate
• The More Money in a Financial System the Less Each Unit is Worth
• Warren Buffett: People Do Not Make Money by Betting Against the US Economy
• The Feds Are Trying to Avoid Deflation
• The Battle Between the Forces of Inflation and Deflation Wages On

There were hundreds of them...different shapes...different sizes. A businessman in a pin-striped suit, briefcase in hand, concentrating on his sales report; he almost stepped in front of a motorcycle. A salesgirl, grotesquely overweight...yellow hair streaked with brown...wishing she hadn't had so much to drink the night before. A lawyer daydreaming about his secretary. A man who would have rather been fishing...still in his waxed coat. A woman annoyed about something. A heavy construction worker, his legs splayed outward as he walked. A tense young woman who dared not look up. A woman worrying about her son. A man thinking about buying a new car. One man trying to remember a line from a song he learned 30 years ago. Another talking to herself. One looked like a doctor taking an afternoon stroll. Another was stark raving mad.

All of them walking along...from one place to another...shuffling along...the living towards the dead.

We were thinking of our children. What a different world they grow up in. And yet, it is still the same too. A man might have been stuck on a London street 50 years ago...and hundreds of years ago he might have watched the same shopkeepers and carpenters walk by, each caught in his own thoughts like a fly in a spider's web.

Our old friend John Mauldin wrote to say that his mother's experience was not much different than ours. She joined the WACs during the war...met John's father...and then nature took her course.

But both John and your editor had a big advantage in life. We both caught the upswing.

Not so with our children. They inherit a different world. America was the world's leading nation in the '50s and '60s. And it was growing in power and wealth - rapidly. We grew up with it. Things were getting better and better...we were sure we'd live much grander, richer, and more exciting lives than our parents. The sky was always the limit!

Now, America is in decline. China's economy grows while hers declines. The Far East has savings, while she has none. The Asia nations are net exporters, making huge profits...while American industries are judged too old, too expensive, and too highly regulated to compete. Americans have debt up the kazoo, while their competitors have little. A young person in America has to look forward to supporting 70 million retired baby boomers...and paying for their drugs, their food, their wars, and their bailouts.

For our children - ours and John's - the situation on a personal level is different too. Coming from poor families, we could look forward to much more wealth and material success than our parents ever knew.

We came back to Ireland this week for a reason that our parents would never have dreamed of. Your editor has set up a family office. It is a very modest affair by family office standards. The typical family office manages a fortune of $100 million, according to The New York Times. We may not even be on the same planet with these rich families; but we are in the same universe. That is, we try to think about...and manage...our wealth as rich people do...as a family legacy or an endowment, not as a retirement fund.

What wealth we have accumulated - even if it is paltry - will be held by a family-owned corporation. Then, the corporation, run largely by the adult children, manages the assets - from our base in Ireland.

Your editor, freed from the responsibility of managing his own money will be free to wander and think...like a vagabond, a gypsy, a refugee, an itinerant mendicant...forced to sup on whatever is at hand and take lodging wherever he can find it - but favoring the Four Seasons and Chateau Margot when they are available.

Whatever else this does, it puts the children in a very different situation from their parents. Instead of starting out with nothing, they're starting out with something. While this would seem to be a big advantage to them, it has huge hidden disadvantages. Like America itself, they are in danger of finding themselves slipping downhill. Instead of expecting things to get better, they may find it hard even to hold onto what they've got. Instead of the "Morning in America" that Ronald Reagan promised, they may find that it seems more like evening, both in their personal as well as their national lives.

"From shirtsleeves to shirtsleeves in three generations," say the French. The grandfather begins without a coat. His grandson ends that way.

But what to do? Spend it all now...so the children begin with the same clean slate we had? Move to Brazil or India - countries with more obvious upside?

In the deep, cosmic end, it probably doesn't matter. The advantage to starting out on an upper rung of the ladder may be about equal to the disadvantage of having to worry about falling off. Who can know?

Every man has to play the cards he's been dealt. What else can he do? He may have a humpback or a beautiful voice. He may have had a hard upbringing or a soft head. He may have a fortune worth of poetry in his soul but not dime in his pocket. As far as we can tell, every young man starts out even. Each one begins life in the same place - where he is. And every generation takes what it is given, and makes the best of it.

The real advantage in life is having the gumption to get on with it; no one knows where that comes from.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• The Family Office
• All You Need is Love… and Work
• Dinner in White
• Life is a Long Hike
• Global Warming and the Children of Israel