But what do you do, dear reader? Buy Treasuries in anticipation of another crash in stocks? Or mortgage your house, long-term fixed-rate, in anticipation of fed-caused inflation?

Ah, there's the tough question. We know where the dumb money is...but where's the smart money? Jeff Clark says it's short stocks. But there's some very smart money that is betting that the government will turn this around. They're putting their money on inflation...or even hyperinflation. Our old friend, Marc Faber, for example, says he is sure the United States is headed for hyperinflation. If so, shorting stocks may not be such a shrewd move. Stocks could soar too - as investors try to buy anything and everything that didn't have dollar signs on it.

You see, there are two ways to deleverage an economy.

The obvious way is the traditional, honest way - in which people actually try to pay their debts. This causes the problems we see as falling asset prices, bankruptcies, joblessness and the other hallmarks of a Great Depression.

But the feds have their hearts set on preventing a depression. And they're doing it the only way they can...by the old 'hair of the dog' technique. The economy suffers from too much debt - so they're going to give it more! Much more. The whole pooch! The whole kennel! Then, they round up every stray mongrel in town. What happens when they run out of dogs? Well...that's a discussion for another day.

We have had many laughs following the feds and their war against capitalism. They're gambling an amount nearly equal to the entire U.S. GDP to try to prevent people from getting what they have coming. In the process, they're almost certain to make a mess of things.

The smart money is betting that they fail to stop deleveraging. But the very smart money is betting that they create a new, worse problem - inflation, maybe hyper-inflation. Inflation reduces the real value of debt...but in a perverse and unpredictable way. Debtors don't pay their bills; savers pay them. Inflation - like bailouts - rewards the least responsible players...those who have gotten themselves heavily in debt...and punishes those who have done the 'right' thing. As Germany saw in the '20s, it de-stabilizes the whole society...leading to extremely unwelcome outcomes.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Capitalism Always Takes an Economy Where it Ought to Be
• Crash, Depression, Hyperinflation – the Triple Crown of Financial Catastrophes
• You Can Have a Deadly Depression and Dizzying Levels of Inflation Simultaneously
• Inflation or Deflation?
• Three Kinds of Money in the Marketplace

But that's just the way globalization works. We have nothing against it, but neither would we mind if there were less of it. Which raises the big question: is the leveraged planet becoming even more leveraged... or less so?

Ah, dear reader... this is where inflation and deflation make common cause. They both de-leverage the world... reducing the value of debt - either by defaults or by lowering the real value of the debt itself. That is the real story in the financial markets... and in the housing market: leverage is being marked down. A residential mortgage worth $200,000 two years ago may be worth only $150,000 now, for example. Bear Stearns - worth billions a few months ago - is now worth peanuts.

Inflation takes leverage down too. All those U.S. dollars held abroad (and at home, for that matter)... all those dollar-denominated Treasury bonds... all those dollar denominated I.O.Us - they all lose value as inflation increases.

Just take those 2 trillion odd dollars outside America. Every one of them is a claim against U.S. assets - land, houses, tractors, food, stocks, buildings, you name it. And as inflation takes prices upwards, each of those dollars falls to the ground... it will buy less of what the United States has to offer.

We have been talking about the battle raging between inflation and deflation. But this is one way to win, no matter which side comes out ahead. Want a sure bet? Bet on de-leveraging. How do you do that? There are many ways. Sell the industry that provides leverage, for example - the financial sector. Sell Wall Street on rallies, in other words.

Yesterday was a good day to sell. After having gone up more in a single day than the entire value of the Dow in '29, it was time to take profits. And that's what investors did. The Dow sold off a little.

Gold, meanwhile, gave investors a buying opportunity. At $887, we're not saying that that is the best price this correction will offer... but it wasn't bad. And many buyers decided to take advantage of it. Gold rose back to $900 .

Now let's look at the U.S. economy itself. Ah... so many foreclosures... so little time.

Food up 9%. Houses down 11%. What's an upside-down homeowner to do but walk away? According to yesterday's USA Today , so many are walking away in Denver that it is producing an 'Exodus' of Biblical proportions. Some neighbours have one out of 8 houses in foreclosure. Citywide, the total last year was one out of 32.

Where do these people go? They rent, naturally. Rental vacancy rates have fallen from 10% two years ago to 5% today

Meanwhile, from Manhattan come two bits of conflicting news: apartment sales are down to an 18-year low... but prices are at an all-time high. Buyers are holding back, in other words... but sellers hold out too - for more money.

Across the nation, repossession filings are up 93% from last year. And as we saw yesterday, food stamps are up big time. But there really aren't any "stamps" any more. Now, the food comes via plastic, a type of credit card that can be used - theoretically - only for buying food. In practice, nice shopkeepers in bad neighbourhoods take the card and give back cash at steep discount. Say a $10 charge for 7 bucks worth of cash to buy life's real necessities - liquor, cigarettes and gas.

It's all going according to plan, as we see it. The empire is rolling over. Now, in its advanced, decadent phase, the imperial government must provide bread - in the form of plastic food stamps... and circuses - in the form of national party conventions, elections and foreign wars. The combination settles the public... and distracts them. They become docile, subservient, willing to stand in line to protect themselves from make-believe threats ... and ready to put up with any nonsense, no matter how grotesque, absurd or faithless.

In the latest financial news comes word of new proposals to "regulate" Wall Street... and new initiatives to "save" homeowners. The free market is out. 'Public responsibility' is in.

Treasury Secretary Paulson:

"I think you will continue to see flexibility as we learn and go forward,'' changing his tune from last month when he said proposals to use government funds were a "non- starter."

Why are they a starter now? People come to believe what they must believe when they must believe it, is our observation. Both private citizens and the government too have taken on obligations that they can't possibly fulfill. Since it cannot be paid, the debt must be made to disappear. The world - or at least most of the Anglo-Saxon part of it, must be de-leveraged. So, people must believe in a fantasy about how the government will "bail out" the homeowners... and how the Fed will "rescue" Wall Street.

How could they perform such miracles? When a man cannot pay for his house, can the feds make the mortgage disappear? When Wall Street has blundered -forgetting to sell its cheesy debt before it started to stink - what can the feds do about it? All they can do is to spray some deodorizer around the room

Still, the voters have been conditioned by television, public education, and maybe something in the water; people will believe anything. And what they need to believe now is that the feds can somehow ease their hurt. This will make it possible to shift the debts that cannot be paid onto the government, where they will not be paid.

Among all the great debtors in the U.S.A., circa 2008, only one has the power to pay its debts - no matter how large they are. Only one has printing presses that turn out pieces of paper with pictures of dead presidents on them. And only one can trade bad debt for political favor. That one is, of course, the U.S. federal government... lender of first, last, and holiday resort.

Already, the Fed has taken onto its balance sheet some $30 billion in smelly collateral from Bear Stearns... and billions more from other financial institutions. That is just the beginning. Somehow, the whole shebang of mistakes, misjudgments, greed-stoked miscalculations will end on the shoulders of the U.S. Treasury... on the backs of U.S. citizens... and dollar holders all over the world.

Bill Bonner
The Daily Reckoning Australia

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