But a warning about what? Sure, stocks, oil, and gold were all down yesterday and the U.S. dollar was up. But is it really the end of the dollar carry trade? And if it is, what happens next?

More cow bell!

We should back up a second. What is the dollar carry trade? It's the engine of bank profit growth this year. It's what's given the illusion that the financial system has recovered from its brush with death last year.

But as you'll learn today, the bankers, the Fed, the media...the whole lot of them...have learned nothing from last year. The hangover was just beginning to set in, so everyone began drinking again heavily. And now the party is wild and out of control. Even the cops are drunk.

Incidentally, this complete abandonment of monetary sobriety and fiscal prudence shows up every day in real life, where the declining value of money is paralleled by a general decline in public behaviour. For example, on Sunday morning we were tucking into a breakfast of banana caramel pancakes (with a scoop of vanilla ice cream on the top) when three incredibly drunk but fairly well dressed middle aged men had a seat next to us at the cafe.

They wanted to chat about the John Birmingham book on the table. They wanted to smoke. They wanted to laugh, and did so loudly to the point where they began upsetting the various dogs assembled in the sun. They ordered a pitcher of beer. They were served. It was 9am and they hadn't been to sleep.

Our cow bell tells us that the financial party thrown by Ben Bernanke may soon be ending. The dollar carry trade, by the way, is where financial firms and speculators borrow cheap money in the U.S. and use it to buy higher yielding assets elsewhere (like the Aussie dollar).

The carry trade is a bubble enabler and balance sheet stabiliser in the short-term. The Fed keeps rates low, the banks borrow and then buy U.S. bonds (which helps the U.S. fund its deficit), buy stocks, and buy commodities. The dollar carry has fuelled the world-wide rally more so than any phantom recovery in the real economy, where employment hasn't recovered and wage growth is hard to find.

What the carry trade has not done is fundamentally improved the balance sheets of the very financial firms that were at risk of insolvency last year. Why not? First, the earnings rebound in the first three months of the year was not driven by better business conditions. Speaking to the Financial Times earlier this week, George Soros said, "Those earnings are not the achievement of risk-takers...These are gifts, hidden gifts, from the government."

The banks booked profits from trading stocks and bonds. And because the Fed, through quantitative easing, was supporting bond prices directly, it was as close to free money/a rigged market as you can get. With enough leverage, even small gains in bond prices were bankable.

But now there is an enormous, gut busting irony to the position the banks find themselves in. Remember that the original idea to repair bank balance sheets and restore their capital positions to healthier levels was to replace toxic mortgage-backed debt with safe, sound, and liquid U.S. Treasuries. Snort. Guffaw.

The irony is that those same Treasuries could be the next big blow up, wiping out the banks thin equity capital sliver all over again, and plunging the financial sector into a second wracking round of forced deleveraging and asset sales. Round two of the recession, morphing into a Depression as the public sector ramps up deficit spending to make up for the collapse in household and business spending.

We all know how much serious the cycle of deleveraging and asset sales was last time around, so it's not a claim we'd make lightly, or without some evidence. So let's get to the evidence. First is an article from Gillian Tett, also in yesterday's FT, titled "Rally fuelled by cheap money brings a sense of foreboding."

"Earlier this month," she begins, "I received a sobering e-mail from a senior, recently-retired banker. This particular man, a veteran of the credit world, had just chatted with ex-colleagues who are still in the markets - and was feeling deeply shocked."

" 'Forget about the events of the past 12 months ... the punters are back punting as aggressively as ever,' he wrote. 'Highly leveraged short-term trades are back in vogue as players ... jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds.'"

" 'Oh, I am sure the banks' public relations people will talk about the subdued atmosphere in banking, but don't you believe it,' he continued bitterly, noting that when money is virtually free - or, at least, at 0.5 per cent - traders feel stupid if they don't leverage up.

" 'Any sense of control is being chucked out of the window. After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months,' he added. He finished with a despairing question: 'Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?'"

This 'latest bubble' is in evidence across all asset markets-bonds, stocks, commodities, property, and cash. Free money does not discriminate on the basis of asset class. But nowhere has the bubble been more generous than in the U.S. Treasury bond market. Short-term U.S. bond yields are vanishingly low. The Fed just purchased $14 billion more in mortgage-backed securities last week and now holds $776 billion in MBS and $773 billion in Treasuries. All up, the Fed's balance sheet is at $2.1 trillion.

But here is the thing: the Fed says it's ready to end its program of buying Treasuries and MBS. It realises it will have its hands full funding big U.S. deficits. But if the Fed withdraws its support for bond prices...you can expect bond prices to fall and yields to rise. This may happen even if the Fed keeps buying bonds...but creditors like the Chinese and Japanese stop (as they have done with agency securities.)

All sorts of interesting things begin to happen now, if by interesting you mean terrible but fascinating. Falling bond prices and rising yields would make perfect sense in a U.S. dollar rally. And a U.S. dollar rally makes perfect sense if the carry trade ends and the dollar shorts cover. Speculators take profits in oil, gold, stocks and jump back into cash and the greenback. This is roughly what happened last time the wheel's came off the financial system.

Where does that leave banks and their massive new hoards of U.S. Treasury bonds? An article called "Bank Insolvency Is Not A Dead Issue" by Daniel Aaronson and Lee Markowitz shows that banks have dramatically increased their holdings of U.S. Treasury securities. When you add their existing exposure to U.S. real estate (facing an Option-ARM crisis over the next twelve months) you have a huge swathe of bank collateral that could face another massive write down.

What do you think that might do the global economy? Aside from putting a few more banks out of business, it would again cut off the flow of credit to small businesses and the rest of the economy. It might again cut off the flow of bank credit from international lenders to the Big Four here in Australia. And this time, what kind of aid can the Feds really offer when their last attempt at help (exchanging Treasuries for RMBS) set the banks up for precisely the implosion they were trying to avoid?

As you can see from the chart above, banks have grown assets again with the Fed's borrowed money. You know have a freshly steaming pile of recovering asset prices supported by a thin wafer of equity capital. It's a fraud with a cherry on top. As the charts below, U.S. banks own nearly $1.5 trillion in government securities. And they are gobbling them up like there is no tomorrow.

There is always a tomorrow. But corporations and institutions live and die just like species. Only the earth abideth forever.

We reckon that the entire financial industry is still dangerously close to a species-destroying event. It's leveraged model of asset growth and debt accumulation imploded last year. But the Fed has brought it back, and like a Zombie/Frankenstein mash-up, it's here to torment us all again.

Soros told the FT this sequence of events is causing a lack of confidence in governments. "There is a general lack of confidence in currencies and a move away from currencies into real assets," he told the FT. "There is a push in gold, there's strength in oil and that is a flight from currencies."

So in the short-term, don't be surprised to see a stronger rally in the USD, which would take some of the starch out of oil and gold prices. As the dollar carry trade unwinds a bit, stock markets will fall and so will other asset classes that have zoomed up on the speculation.

But the bigger story playing out is this: the entire method by which the fiscal welfare state funds itself is blowing up. More on how this will happen and what it means tomorrow. Until then, we hope you heard the cow bell.

Dan Denning
for The Daily Reckoning Australia

• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• Fed Announced it Would Buy up to $300 Billion in Treasury Bonds
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• It Wouldn’t be a Real Bear Market Rally if it Didn’t Test Your Confidence in Your Position
• The Only Thing Really Going Down Right Now is the U.S. Dollar

"Why so high...so fast?" That was the question in our Daily Reckoning analyst meeting this morning.

"In the last big boom in gold - in the late '70s - gold followed inflation...and the central bank. Investors saw inflation increasing. And they saw the central bank failing to react fast enough. They bought gold to protect themselves.

"But now...there is no inflation. And central banks are alert to the problem. They haven't raised rates...but they don't need to. There's no need to protect against a problem that doesn't exist. So what are investors trying to protect against?"

No one at the table had a good answer.

"They're just looking ahead to when all that money the feds put in the system finally shows up in inflation. If you believe there's a real recovery you might think it is coming soon..." said one analyst.

"They're worried about a crash of the dollar...they're just buying gold because it's the anti-dollar..." said another.

"Maybe the Chinese are switching their reserves to gold...just like they said they would. And maybe instead of buying at below $1,000 they're buying quietly below $1,100..." offered another.

"Gold is being re-monetized," says MoneyWeek editor Simone Wapler. "All the world's paper monies are losing value - and credibility. There's a race to the bottom as they try to devalue their currencies."

All countries are fighting for market share. In a price-sensitive world, they increase exports by cutting prices. And the fastest - sometimes, the only - way to do that is by devaluing the currency. But when one nation devalues - say, by printing extra money - other nations must devalue too in order to stay competitive.

What can they all devalue against?

"Gold is rediscovering its old role," says Simone. "Once again, it is the way we preserve wealth and keep track of what things are worth."

Your editor had his say too.

"Most people are buying gold only because gold is going up. Maybe they realize that the world's financial system is in a period of crisis. They see the central banks are being derelict in their duty. Instead of protecting the value of their paper money the bankers are intentionally undermining it. They figure that if the central banks aren't doing their jobs - that is, if they aren't maintaining a reserve of real money - they'll have to do it themselves. Each person now needs to be his own central bank, with his own reserve of real wealth - gold.

"Or maybe investors don't see that all. Maybe they just see the price going up and they want to hitch a ride. What else can they buy that has been going up for the last 10 years? Gold is up $150 - about 17% - in the last 6 months. It's up 27% in the last year. It's up 300% since 1999."

Gold is in a bull market. How far it will go and how long it takes it to get where it is going, no one knows. No one knows, either, how many scrapes and setbacks it will suffer before it finally reaches its destination.

But it is a bull market. And you don't ask questions in a bull market. You get on board and ride it to the end.

Then, you wished you had asked some questions.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• We are Confident the Bull Market in Gold is Not Over
• A Bull Market in Gold and Gold Alone
• China is a Key Driving Force in the Gold Market
• Gold Falls for Four Straight Days but is the Low Price a Bad Thing?
• Price of Gold Today is About Where it Was 26 Years Ago

Let's take the earnings recovery story first. Tomorrow we're going to have a look at the outlook for Aussie bank earnings. But for now, is there a case to be made for stocks as an asset class? Are they really recovering?

Well, the S&P 500 closed down in New York. But it's up 57% from its low. That's impressive. It's also expensive. The index now sells for 20 times operating profits, which is pretty optimistic, given how crappy the world economy has been in the last year.

"But that was last year," you say. In the future, things can't help but be better! And relatively speaking, that's probably true. Our friend Dan Ferris writes, that, "Last year, the S&P 500 lost $23.25 per share for the fourth quarter. In the second quarter of 2009, 369 out of 478 companies, representing perhaps 97% or 98% of the total market cap, reported negative earnings over the previous year."

Compared to last year, this year HAS to be better. You can't get much worse than negative earnings. And with trillions in credit backstopping the financial system and making it possible to generate profits on paper assets, you'd expect to see at least some engineered earnings in the next two quarters that look absolutely dazzling when compared to last year's numbers.

"So," says Dan, "for the next two or three quarters, you can expect plenty of reports of vastly improved earnings, even if those results aren't really so great. As you parse the news and evaluate your own investment goals, keep your head about you and don't be afraid to spend extra time getting deeper into a company's numbers, its market, its history, and its future prospects than you normally would. And for Newfoundland's sake, don't buy anything that isn't dirt-cheap."

Absolutely speaking, the popping of the credit bubble fatally undermined the business models of a lot of heavily leveraged companies, including many, many banks (both big and small). We reckon that the capital cushions of those banks are still in danger from further falls in asset values. Yes, that's not a popular or even common view. But we'll expand on it tomorrow.

In the meantime, you can always tell when stocks are out of favour in Australia. Everyone starts talking about what a good investment property is. But Australian housing is not exactly a cheap asset. The Governor of the Reserve Bank, Glenn Stevens, said as much earlier this week.

And this morning, we peeled our eyes over this paper on Aussie houses by RBA man Tony Richards. Richard's inadvertently made a lot of interesting points. One was that the so-called improvement in affordability over the last year is, "mainly due to movements in interest rates rather than in house."

He added that, "Mortgage rates are particularly low at present and, as the Bank has noted on a number of occasions, it is not reasonable to expect that interest rates will stay at the current low levels indefinitely. When they do rise towards more normal levels, discussions on housing affordability will again focus more on the level of housing prices relative to incomes."

That is clever to suggest that when rates rise people will have to find another way to say that houses are affordable. But we reckon when rates rise, as they eventually must, a lot of new home buyers will find out that access to cheap credit does not make a house affordable. It just makes the amount of debt you owe to the bank a lot larger.

The most interesting part of the paper, for our twenty minutes, was the discussion of 'underlying demand'. 'Underlying demand' is the phrase that gets trotted out when the banks and real estate brokers tell you there's a housing shortage, or when the RBA tells you not to worry about a house price crash in Australia. But what does it really mean?

Richards says the four components of 'underlying demand' are population growth, household size, new houses to replaced demolished homes, and demand for "second or vacant homes." Note that none of these are like the Ten Commandments. They aren't carved in stone. They are changeable.

By the way, who on earth can afford to own a home they neither live in, nor rent? "Honey we're going to buy a third home. But we're not going to generate any rental income from it. And we're certainly not going to live in it. We're just going to pay the mortgage on it."

"But why would we do that dear?"

"Because we can. To show how rich we are. We can afford it. And to support underlying housing demand. What else are we going to do with that money, buy stocks?

Returning to reality, Richards says that a preference for smaller household sizes, along with rising incomes and a rising population all factor in to strong "underlying demand." But if you spend exactly forty two seconds scrutinising this claim, you'll find that it simply doesn't hold up. "Underlying demand" as a bullish factor in Australian housing is a fiction propagated by property spruikers and money lenders.

Take rising incomes. Rising incomes are a function of a growing economy. But in a prolonged recession—or just a period of slower growth, or a world in which wages in the Western world are gradually deflated as the global work force grows (especially in manufacturing)—income growth is going to be harder to achieve across the economy.

And rising populations? Well, it's always possible for the government to reduce legal immigration if it's concerned about too many people competing for too few jobs. That knocks another plank out of underlying demand.

And then there's the preference for smaller households. Of course there's a preference for having your own castle and being your own King, if you can afford it. But the RBA's own data show that after many years of smaller and smaller household sizes, the trend is now swinging to larger households.

This could be by preference. After all, living alone has its benefits, but it can be awfully lonely. Or it could be by necessity—children living at home longer to save money or taking on flatmates to ease the pain of higher rates.

But whatever is behind the trend in rising household sizes, the main point is that the elements that go into "underlying demand" don't automatically suggest a level of demand for houses that will always rise. Quite the contrary, in fact.

And of course one of the biggest factors in demand for housing is the availability of credit via low interest rates. We reckon that when you add a couple of hundred basis points to the current cash rate, you'd take quite a bit of momentum away from "underlying demand" for housing.

How about some reader mail?

Dear DR,

Phil Cantrill

Intriguing scenario. Politically, it's a mess. Financially, we reckon the big issue is the value of toxic CDOs to banks and financial firms. Regardless of what happens to homeowners, those CDOs are due for a haircut. And when that happens, watch out for more bank failures and a second buffeting of the financial system.

Hi Dan,

Peter H

Dan Denning
for The Daily Reckoning Australia

• Aussie Housing Market Actually Leads the U.S. by Three Years
• Property Spruikers Claim Australia Suffers from a ‘Chronic Housing Shortage’
• The Australian Resource Boom Isn’t Dead Yet
• The Mother of All Housing Booms
• Housing and Unemployment Are Weaknesses in the U.S. Economy

When you intervene in a place like Iraq, it is like a bad marriage. The first few nights are fun. But soon you're looking for a graceful way to get out. Trouble is, there isn't any easy way out. So you stick with it. Time goes by. And the costs mount up. Before you know it, the cost for the Iraqi adventure is more than $1 trillion...and then it goes to $2 trillion.

Now, the feds have intervened in the economy too. And, likewise, they are trapped. By pumping in trillions of dollars - not just in America, but also in Britain and China (which have both intervened even more forcefully) - they have made it look like things are okay. They have kept zombie companies alive. The big banks haven't had to own up to their own mistakes. Companies haven't had to cut back quite as much as they would have.

As our friend Nassim Taleb puts it, the financial system "still has the same disease."

But it's being kept alive with massive doses of very expensive medicine - provided by the feds.

So what are they going to do now? They claim to have prevented catastrophe. They say they've engineered a recovery. And yet, if they let up on the drugs...the patient dies.

They're trapped...they'll have to keep pumping in money for years...until the money runs out.

Naturally, the feds want to raise as much money as they can. So, like bank robbers, they go where the money is - to the "rich."

Steve Sjuggerud tells us what has happened back at home...in Maryland.

"The state of Maryland couldn't balance its budget last year. So the state decided the right way to raise tax dollars was to fleece the millionaires... Maryland state politicians created a 'millionaire' tax bracket.

"Maryland Governor Martin O'Malley of course expected tax receipts to go up. He said Maryland's 3,000 millionaires were 'willing to pay their fair share.' The Baltimore Sun said the rich would 'grin and bear it.'

"But the opposite happened...

"Instead of 3,000 Maryland millionaires filing taxes in April 2009, only 2,000 did. According to The Wall Street Journal: 'Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year - even at higher rates.'

"A friend of mine lives here in Florida. He is not an American citizen. He pays US taxes while he lives here. But under the threat of higher national income taxes, he is contemplating giving up his green card and moving elsewhere.

"When Maryland's governor raises taxes, Maryland residents leave and government income goes down.

"When the nation's President raises income taxes, foreigners like my friend leave and government income goes down.

"Unfortunately, YOU CAN'T LEAVE.

"Wait a minute. This is America, land of the free, right?

"Not so fast... The US government will track US citizens everywhere to get tax money. If you leave to work in another country, you still pay US income taxes. America and North Korea are the only countries that tax you on your worldwide income.

"If it gets bad enough, you can just give up your citizenship, right? Nope, you can't do that either. At least, you can't do it without paying a potentially massive 'exit tax.'

"The exit tax acts like an estate tax. If you want to give up your citizenship, you have to give up nearly half your wealth above a certain level. The Economist magazine calls it 'America's Berlin Wall.' Nice, eh?

"Want some more nice? Once you're gone, you're not legally allowed to come back and visit family and friends. Yes, if the government decides you have renounced citizenship for tax purposes, a federal law prohibits you from entering the country ever again. (You can look up the rule under 8 USC 1182(a)(10)(E).)

"You can escape states with oppressive taxes. But 'escaping' the US - the land of the free - is much more difficult. And you can bet it won't get any easier as the government needs more and more of your income to pay its bills."

Bill Bonner
for The Daily Reckoning Australia

• U.S. Presidential Election
• Rare Coins as an Informal Way of Estate Planning
• You Can Have a Deadly Depression and Dizzying Levels of Inflation Simultaneously
• Playing the Tax Credit Card
• Politics is About What You Can Get Away With

The burden of today's Daily Reckoning, then, is to remind these nattering nabobs of negativism that gold is not anyone else's debt. It is not anyone else's liability. It cannot be created with a few keystrokes. And for thousands of years, millions of people from all walks of life have been happy to use it as money because of its unique features (divisibility, durability, scarcity, difficulty in counterfeiting).

Gold is a commodity. But its price is not driven exclusively by the Indian jewellery market or investment demand. As a tangible commodity, gold has some of the aforementioned qualities that make it a fantastic medium of exchange.

And for people who trot out the canard that you can't buy a Big Mac with gold coins, what do you think goldsmith's notes were? They were receipts that indicated gold ownership and your ability to pay a debt. You could exchange goldsmith's notes as payment for goods and services because the paper claim was backed by a real asset. Goldsmith's notes were the precursor to bank notes. Same type of system, but with real money.

Is this all just some nostalgia for a financial system that no longer exists? Does gold have a real role to play in the future financial system? Of course it does! Gold is a threat to the fiat money peddlers from the warfare/welfare State because it exacts a heavy price for deficit spending and money creation. The expansion of credit or deficit spending is always possible in a fiat money system and thus placates voters with false prosperity borrowed from the future.

The rise in the gold price is telling us that markets are increasingly suspicious of the government-backed money and its ultimate affect on the real economy. Or, as guest essayist Greg Canavan says, " Gold is saying that the crisis is not over, that it is in fact getting worse. We are seeing Gresham's Law in action, as bad money pushes out the good. Gold is being swept off the market by millions of individuals who know that without fail governments always ruin the value of their paper money."

The only real - albeit shallow - criticism of the gold story is that it's primarily a U.S. dollar story. For Aussie investors, a collapsing greenback doesn't equate to a higher Aussie-dollar gold price. We would say, though, that this is a short-sighted appreciation of what gold is saying about the modern money system.

The modern money system is built on credit, debt, and government money backed by nothing. To believe that does not mean you'd covert all your assets to bullion, or all your shares to gold stocks. But it IS to believe that the architects of this system are criminals who effectively steal your wealth through inflation and control of the money supply.

If you have confidence in that system, you're a sucker. And if you don't hedge against its collapse, you're unprepared. After the last two years, is it so farfetched to believe that the foundations of financial capitalism - based on unsound money as they are - are weak by design and will fail in a world of increasing complexity and interconnectedness?

If you don't think it could happen, you haven't been living on Planet Earth. Either that or you're in a business where you want everyone to go back to doing what they were doing pre-Lehman collapse because it's good for your business. If that's the case, it's fine. But it's foolish to ignore 5,000 years of monetary history.

Yesterday we wrote about what happens when a complex network of trade and commerce begins to shrink as credit is withdrawn from the global system. Another side effect of the Lehman collapse is a bear market in trust. Trade, once free flowing and robust, becomes politicised. Trading partners begin to bicker.

Take Barack Obama's decision to slap a large import tariff on tyres made in China. It will probably just drive up the cost of cheap tires of middle-income Americans. But it makes America's unions happy, and Obama needs them to push through his health care agenda. China has responded with warnings about possible tariffs on U.S. poultry and auto parts exports.

It's probably not in neither country's economic interests to get in a trade war. But it reflects the ambiguity and hypocrisy of trade practices by both countries. There is no such thing as free trade. China subsidises production with cheap labour and produces at below production cost for some goods and services. America is happy to lose those manufacturing jobs if American shoppers get lower prices and have access to credit to make up for falling real wages.

But that whole strange relationship that has driven global growth for the last ten years has reached its use-by date. We're not sure what's going to replace it. But both parties are guilty of being currency manipulators and subsidisers. Formerly, their interests were aligned. Now, it's not so clear.

And finally a note from JL in Queensland about networks, nodes, and certain monetary commodities.

"Just my two cents worth. The difference between a node in a computer network vs. a node in the financial/economic system is that the node in the network can be self sustaining (provided that it's plugged in to electricity), whereas, most of the nodes in the financial/economic system are NOT self sustaining.

"The ONLY financial/economic node that would be self-sustaining and immune from ALL shocks (i.e. Exhibit the financial equivalent of homeostasis) is one that is 100% backed by a financial asset which is no one's liability. I'll leave you to guess what THAT financial asset may be.

Dan Denning
for The Daily Reckoning Australia

• Important Financial Anniversary: Collapse of Lehman Brothers
• Will Synchronized Rate Cuts Solve International Financial System Problems?
• Fed Willing to Print Money to Buy More Bonds to Keep U.S. Interest Low
• Is China Trying to Back its Currency With Metal?
• US Dollar As Reserve Currency Not Working Very Well

As for Tim Geithner, he takes no chances; he sings his own praises. Speaking to a gathering of the G20, he congratulated them all:

"...facing the greatest challenge to the world economy in generations, the G-20 gathered here in London and committed to an unprecedented program of policies to restore growth and reform the international financial system. Those actions have pulled the global economy back from the edge of the abyss. The financial system is showing signs of repair. Growth is now underway."

Stocks are still up. Commodities too. Oil is over $70. And most encouraging of all: the 10-year US Treasury note yields only 3.47%. So what evil sends investors running to the protection of gold? None at all, say the papers; investors buy gold in anticipation of better times. They see a recovery, bringing with it tightened supplies and rising demand. Every economist, investor and hair stylist knows what this means - inflation.

But if growth is underway, investors should be glad there is not more of it. The key indicators of real economic progress are negative. Unemployment is not rising; it is falling. Nearly 7 million Americans have lost their jobs since the recession began. In California, only 3 of 5 working age residents have a job. And those who are still working are putting in the shortest workweeks ever recorded. How could the economy be growing with fewer people earning money? The New York Times attempted to explain the enigma by calling it a "jobless recovery." But a recovery without jobs is like a loveless marriage or a fat-free burger - it is disappointing.

Another key indicator is personal spending. Not surprisingly, that is down too. Personal spending has fallen in four of the last six quarters - something that has never happened before, since they began keeping records in 1947. The level of consumer spending is down 33% from a year ago - with discretionary spending in the United States now down to a level it hasn't seen in 50 years. Consumers aren't spending partly because they have no money...and partly because they apply what money they have left to relieving the headache from their previous binge. A report this week showed they had reduced their hangover of personal debt in July by more than $21 billion - four times as much as economists forecast. These are, of course, the same economists who pimp for the angels at Bernanke & Co. If they're right, we have a spending- less, jobless recovery pushing up the price of gold.

We offer an alternate interpretation. We begin with a doubt about the one now on the table. In the popular version, the more the recovery seems real, the more investors fear real inflation. This drives them to buy gold. Of course, it should drive them to sell US Treasury bonds too - which hasn't happened. Nor has inflation gone up. And if this view were correct, we should begin to see remedial measures from the US central bank. The Fed should soon begin to withdraw its monetary stimulus, returning the economy to a kind of normalcy it hasn't seen in years. The risk, not insignificant, is that Fed economists will err. They may loosen monetary policy too slowly or too quickly. Asked about the risk, Janet Yellen, President of the Fed's San Francisco branch, promised to avoid the error of 1937 - she will not "tighten policy too soon, aborting the recovery."

Gold bulls are counting on her. And they may be right. But here on the back page, we add a nuance. We're not surprised by an occasional Fed error. What surprises us is the rare accidental success. There are 500 basis points between zero and 5%. It would take a miracle for central bankers to find exactly the rate the market needs precisely when it needs it most. The '37 error, for example, might have been a success. At least it sped up the process of liquidation so the decks were clear when the post-war boom finally came.

Maybe we'll get lucky and the Fed will make the same error again. Not likely. This time they'll make a different error - adding too much cash and too much credit for too long a time. Today's 'recovery' is based on hot money from the feds. It's a fake. It won't cause real growth. When this becomes clear, commodities will sink - along with stocks...and gold. Central banks, ignoring the futility of their hot money program so far, will add even more hot money. Eventually, the hot money will cause inflation to rise and gold to 'melt up.' Gold bulls will be proven more right than they imagine. But they may be proven wrong first.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Feds Want to Increase the Money Supply and Induce People to Spend Money
• Economy Has to Grow at 1% to Stay Even With Population Growth
• RBA Rate Cut Does Little to Unlock Credit Market
• Where, Exactly, is this Economy Headed?
• Feds’ Plan is to Reflate the Economy

The story goes, Achilles was dipped in the river Styx and made invulnerable. But his mother held him by his heel, leaving that part untouched by the magic waters. Naturally, that is where a poison arrow got him.

The moral of this story is that you have to go all the way. If you want your baby to be invulnerable, put him all the way under the water...even the heels. Or, maybe there's another point: that there's always some place where you're vulnerable.

For the purpose of today's tale, we'll take the second possibility. Try as you may, you can never escape all risks.

All over the world, consumer prices are falling. The world has too much capacity...too many factories...and too many workers. Too many, that is, for current demand. The 'world's mouth' - the USA - has gone on a diet. And if the United States reduces its intake, that means the rest of the world - especially China - must reduce its output. Otherwise, the whole thing will become unbalanced.

Yesterday's news tells us that despite press reports of a recovery, the key indicators of real economic growth are still falling. Almost one out of ten mortgages are now delinquent. And the rate of foreclosures is increasing faster than any time in the last 30 years. Housing prices, meanwhile, fell 16% in the 2nd quarter, from a year earlier, according to the National Association of Realtors.

Unemployment claims went up last week. The sharp eyes of The Financial Times see the link: "Mounting joblessness fuels US housing crisis," says its headline.

In the real economy, people are cutting back...with the inevitable results we discuss every day here in The Daily Reckoning. One major consequence of reduced demand is too much supply. The factories built in China to supply products to America during the bubble years now find they have no market.

Currently, overcapacity and oversupply are causing prices to fall. Falling prices mean rising currency values. Each unit of 'money' buys more stuff. But there are many competing currencies, and they don't all rise and fall together. Even in a world of deflation, some currencies will deflate more than others.

The dollar is, of course, the world's main money. In a sense, the whole world economy is under its heel. But it is a heel that has never been dipped in the river Styx. It is now a heel that waits for an arrow.

PIMCO is the biggest manager of bond funds in the world. It says the greenback is going to lose its status and lose its value.

"Investors should consider whether it makes sense to take advantage of any periods of US dollar strength to diversify their currency exposure," says its Emerging Markets Watch report. "The massive amounts of US dollar liquidity produced in response to the crisis" doom the currency.

Both China and Russia are calling for a new global currency to replace the dollar.

"While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the US dollar as a store of value even in the absence of a single viable alternative," continues the PIMCO report.

Meanwhile, our old friend Jim Rogers says he is moving all his assets out of dollars and buying Chinese yuan. And Warren Buffett warned this week - writing in The New York Times - that "greenback emissions" threaten the whole world econo-system.

But what does it mean? What are the threats to you? What are the opportunities? If you pay your bills and keep score in dollars, what does it matter if the dollar loses value against the yuan? If prices are generally falling, the dollar is actually getting stronger, isn't it? So what if some other currencies are getting even stronger still?

Colleague Bill Jenkins, at Master FX Options Trader puts in his two cents:

"We lived through a financial earthquake in 2008. The effects of it are still being felt. Aftershocks may still be ahead. But predicting when they'll strike is just as hard as predicting natural earthquakes. We had a number of prognosticators for years telling us about what would happen last year; it's just that they didn't know when. And that is the hard part of the life of a prophet.

"And while it is equally difficult to tell when the next economic tremors will hit, we can look at the numbers and make some predictions as to their cataclysmic effect."

Bill goes on to say that he thinks the US is headed for another shockwave...which will include another round of dollar buying - even while the 'experts' are touting 'green shoots' and a return to normalization.

The trouble with the Achilles' heel is that it is connected to the Achilles' tendon...which is connected to the leg muscles...which is what keeps the whole thing moving forward. Cut the tendons and the feet go flippety, floppety and you get nowhere.

Yesterday came word that the US deficit for 2009 might come in lower than expected. Instead of borrowing $1.8 trillion as anticipated, the feds might only borrow $1.58 trillion. Well, that still leaves them about $680 billion short - even if every dollar of trade deficit and every dollar of domestic savings is applied to it. But definitely a step in the right direction! This gap must be closed by quantitative easing, or, in other words, by printing press money. So, holders of old dollars are bound to wonder how much their savings will be weakened by the addition of so many new ones.

They're likely to wonder, too, how much those US Treasury notes will be worth after this monetary inflation catches up to them. At some point, they are likely to think twice about buying more of them...and possibly even want to sell the ones they have already. Either way, it could create a nasty financial whirlpool that sucks down the entire world economy. As private investors reject US dollar credits, the Fed would be forced to print up more money to buy them itself. As the Fed buys more, private investors become more fearful that this monetary inflation will lead to consumer price inflation; they may panic and dump all dollar-denominated assets.

But if investors drop the dollar, what do they take up in its place? Oil...maybe. Oil is selling for $72 a barrel, even while the world is in a major downturn. What makes it so expensive, if not the fear that the currency in which it is quoted is more slippery than the black goo itself?

And gold? Yesterday, gold lost $3. But is still trading in the mid- $900s - not far from its all-time high. And this at a time when consumer price inflation is going down! In the US non-oil export prices are falling at a 5% rate. If people are buying gold as a hedge against inflation, they must know something we don't. Consumer prices are falling...actual CPI rates are negative in many countries already. Take out the effect of speculation on oil and commodities, and deflation is probably a fact of life almost everywhere. Gold buyers are not hedging against an increase in the price of bread, in other words; they're hedging against a poison arrow directed at the dollar itself.

Though gold may not make you rich tomorrow, as a long-term investment, there's nothing better. Strike while the iron is hot...or, while gold is relatively cheap. It's sure to get much higher than it is now...perhaps as high as $2000 an ounce.

Bill Bonner
for The Daily Reckoning Australia

• A Dollar Crash Will Have Disastrous Implications for Global Financial Markets
• Will Synchronized Rate Cuts Solve International Financial System Problems?
• 4 Ways to Protect Against a Falling Dollar
• The More Money in a Financial System the Less Each Unit is Worth
• Prices of Gold in the Top 10 World Currencies

Here is Warren Buffett's view:

"Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need.

"They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue.

"The United States economy is now out of the emergency room and appears to be on a slow path to recovery."

This is probably the view shared by most economists and most investors. It is not our view. From where we sit there is no recovery underway...and there never will be one. You can recover from a hangover. You can recover from a nasty divorce. You can even recover from an earthquake. But once a depression begins, you can only endure it. Get on with it. Get it over. And then, you can begin rebuilding again. You will never recover the economy you had before the crisis. You must find a new economic model.

A headline from yesterday: "Reluctant shoppers hold back recovery."

That's one way to put it. Shoppers don't have any money. They need to cut back. Most likely, they will cut back until their savings rates reach 10% of disposable income. That will take $1 trillion out of consumer spending. The economy cannot possibly recover under those conditions; it can't return to its same old, consumer-led, credit-fuel self. Instead, it must go through a period of transition - in which output is depressed - until it finds a new personality, better suited to the new economic circumstances.

But Buffett is not worried about the depression. He's worried about how the recovery is financed:

"...enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself."

Buffett does the math. This year, the US deficit will total $1.8 trillion. Since 1920, the largest peacetime deficit was 6% of GDP. This is 13% of GDP. The magnitude of it alone should be cause for alarm. But there's more. Where does this money come from? Even if you could direct 100% of the net US trade deficit (about $400 billion, the money that ends up in foreigners' hands as a result of American spending) and 100% of American's savings (estimated to be about $500 billion), you'd still be $900 billion short.

Desperate borrowers should expect to pay high rates of interest. A borrower who doesn't need the money can shop for the best rates and hold out for a good deal. But when a person needs to borrow, he takes what the market gives him.

Yet, one of the most curious things about the financial world circa 2009 is the yield on the 10-year Treasury note. It has fallen to under 3.5%. Despite record borrowing by the feds, lenders content themselves with the lowest yields in nearly half a century. Go figure.

The market seems to be anticipating a depression. Why else would bond yields be so low? If the economy sours...and the stock market sinks...the safe yields on Treasury bonds will seem like a good alternative. But Buffett believes the Treasury yields are not as safe as they appear. That other $900 billion has to come from somewhere. And the feds can't allow interest rates to rise significantly; that would undermine all their stimulus efforts. High real interest rates depress economic activity. So, what can the feds do?

"Washington's printing presses will need to work overtime," says Buffett prophetically. Of the two ways of financing the deficit, one is a flimflam; the other is robbery. In the great credit expansion consumers borrowed so they could buy things such as automobiles. Now, the feds borrow and bribe the voters with money to buy automobiles.

No matter who does it, borrowing for consumption is merely taking from the future. Then, when the future comes...the account has to be settled. Result: no net gain. What was consumed in one year is not consumed in the next.

Of course, the feds don't spend money the same way consumers did. Consumers wasted their money on frou-frou and watchamacallits of their own choosing. The government wastes money on different things - like turtle crossings and billion-dollar bailouts.

Not that we're complaining about government spending. We're just pointing out that it's not the same as private spending. What makes goods good is that people choose them and buy them with their own money. They get what they've got coming. But the feds are spending other peoples' money. If they get any goods at all it is practically an accident.

But what we're talking about this morning is the dollar. According to Buffett, the dollar is in danger. He's worried about the larceny, not the flim-flam. Printing up additional dollars robs savers. Each new dollar created to buy US debt makes each one already in existence - say, in a vault in the Bank of China - worth less than it was before. If that isn't true, the whole body of economic thinking from Adam Smith to Irving Fisher is nothing but a fantasy. And the only way to protect the value of the dollars held by savers, theoretically, is to withdraw the stimulus money before inflation sends prices soaring.

Buffett is an optimistic fellow. He believes that responsible authorities will turn off their dollar-printing machines in order to protect the greenback. Here at The Daily Reckoning, we're not so sure.

First, the depression is likely to be worse than people think. This will mask the effects of dollar printing. Plus, it will make the need for more dollars - more federal spending, more US debt - seem more urgent than ever. Instead of pulling the plug, they'll turn up the speed.

Second, the feds are not really interested in the health of the real economy anyway. This is an insight, which while it may seem obvious, it only came to us recently. When the feds put in place absurd policies to delay and restrain the inevitable correction, they are making things worse, generally, for everyone. But the politicians are responding to their constituents' demands. One campaign donor wants to keep his business alive. Another wants to keep his job. Still another promises the feds high paying jobs on Wall Street, after their term in Washington is over. Millions of others - more than enough to turn an election - want free pills and mortgage subsidies and so forth. When the feds try to bailout the economy, they are only doing their jobs! They're not going to stop doing their jobs - especially in a depression - just to protect foreign dollar-holders.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Warren Buffett Says American Economy is a Shambles
• The Fed Cut Rates – But How Low Will They Go?
• Is Inflation Necessary for Recovery and Growth in the United States?
• The More Money in a Financial System the Less Each Unit is Worth
• Gold is in a Bull Market

O! Bama! Where is thy recovery?

Yesterday, the world's stock markets took a hit. The Dow lost 186 points...following a very bad showing in China.

Is this the end of the rally?

Could be. We're not betting one way or the other. But we're pretty sure this rally is going to end...and end badly...sooner or later. So far, the rally surpassed the rally in '29 by a few weeks...but has not quite reached its magnitude. It will need another few hundred points to reach the '30 level.

But when the rally is over...then what?

Despite the fact that a majority (!) of economists polled by The Wall Street Journal say the recession is already over, there is no durable recovery.

Nouriel Roubini, writing in Forbes, explains why:

"Data from the US - rising unemployment, falling household consumption, still declining industrial production and a weak housing market - suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.

"Moreover, for a number of reasons, growth in the advanced economies is likely to remain anemic and well below trend for at least a couple of years.

"The first reason is likely to create a long-term drag on growth: Households need to deleverage and save more, which will constrain consumption for years.

"Second, the financial system - both banks and non-bank institutions - is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.

"Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending.

"Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth."

Roubini thinks the United States will climb out of recession towards the end of the year...but then, it could fall back into a 'double-dip' recession. Maybe he will be right. Maybe this downturn will resemble Japan's multiple recessions over the last two decades. Or maybe it will be a single, deeper and longer lasting slump - like the one in the early '30s. We don't know. Either way, it should be thought of as a depression, not a recession. Because it is fundamentally different. And the difference is: Recovery is impossible.

If the markets were to recover, it means they need to go back to the way they were. That, dear reader, ain't gonna happen. Because it can't happen. The economy can't go back to what it was. In the 2005-2006 period, it was in the throes of a credit cycle blowout...where it took more than $5 of new credit to produce one stinkin' extra dollar of output. Consumers had to borrow $100, in other words, in order for the GDP to go up $20. It was a period of madness that couldn't possibly be sustained...and now, can't possibly be revived. Who's going to invest in another condo development in Florida now? Who's going to buy derivative debt at 2006 prices? Who's going to build another factory in China to produce more things for American consumers who can't pay for them?

Well, ha ha...that's the funny thing; the Chinese ARE building more factories.

But we'll get back to that later. Comes word this morning that Florida has lost population, for the first time since 1946! People are leaving the Sunshine State because the big boom in suburban sand is over. A large part of the Florida economy was based on building houses for people coming down from the north. Now those people are going home and trying to pay off their debt. The point is, after a bubble...like after adultery...things never go back to where they were before. You can pretend that they are the same. You can act like they are the same. You can try to make them the same. But they never are.

A recession is merely a sprained ankle or a head cold. You can recover. But a depression is fatal. There is no going back. There is no recovery.

Trying to 'recover' from a depression is a futile fight with the future. Governments try to restore the old economy - as it was. They prop up the old industries. They bail out the failed executives and speculators. They pass out money to people, encouraging them to make more of the same mistakes that got them into trouble in the first place.

But there is no going back. It's a depression. The model has to change. The future...whatever it is...has to express itself.

The US budget deficit hit a record $180 billion last month. July's deficit was nearly $30 billion more than total tax receipts for the month. In July, the feds only took in $151 billion in taxes...giving it the worst margin in history. For every dollar of revenue, the federal government spent $2.15.

Not a very good business model. But the feds seem determined to stick with it - they're going to make it up on volume. Deficits are expected to exceed $1 trillion every year for the next eight years. And that assumes the economy 'recovers.' If it doesn't recover, the deficits will be much worse...with falling tax revenues and the need for even more stimulus.

The feds are running into the brick wall of the future. They've made promises - mainly to older voters - that now have to be fulfilled. And the number of older voters is increasing...as the Baby Boomer generation enters its retirement years. Social Security and health care promises alone will add trillions to federal deficits. By one estimate, US debt could rise to 300% of GDP by the middle of the century.

Of course, this poses a bit of a problem. US GDP is about $14 trillion. Three times that amount would be $42 trillion. Who's got that kind of money to lend to the US government? No one. The first reason being that the world doesn't have that much in savings. Second, because even if they did, they are unlikely to want to lend it to such a huge debtor. Of course, we're always surprised by what people are willing to do with their money - and anything is possible.

But more than likely the US will be forced to trim its promises...or inflate them away.

As dear readers know, we have become suspicious of inflation. Not that we don't expect it; in fact, we think we'll see it in its souped-up hyper version sometime in our lives. What we're suspicious of is the easy assumption that the feds can create inflation at will...and control it. They can't. They aren't that good. Even at inflation they are hapless and incompetent. And their hands aren't completely free.

First, they have to answer to the Chinese bond vigilantes. The Chinese are watching. If it looks like the feds are increasing the inflation rate - thereby reducing the value of Chinese savings - they could send the US government and the US economy into chaos simply by selling their stash of Treasury bonds.

Of course, the Chinese don't want to do that - because it would mean hundreds of billions in losses. But push them far enough...make them afraid enough...or cause them to get mad enough...and they could strap on their shootin' irons.

Second, there are also the ineluctable results of a major credit contraction...and a gross oversupply of capacity. Both are pushing down prices and could do so for many, many years. They can be overcome by aggressive use of the printing press. Argentina and Zimbabwe proved that. But neither Argentina nor Zimbabwe depended on credit from the Chinese. Inflation may be a monetary phenomenon, but hyperinflation is a political phenomenon...the feds only resort to it when they have no choice. We'll get to that point; but right now, it is still far away.

Bill Bonner
for The Daily Reckoning Australia

• We Expect No Recovery from the Economy
• Roubini Says Recession Will Continue Through End of Year
• Americans Have No Money to Spend Because They Already Spent It!
• China Was the Maker and the United States Was the Taker
• Is Inflation Necessary for Recovery and Growth in the United States?

And unknown it will remain for the rest of today's Daily Reckoning. The ins-and-outs of public policy are beyond the scope of this publication. So we leave the stimulus package to its own devices and push on to other issues in the world economy and financial system.

Bloomberg reports that the Baltic Dry Index "rose the most since at least 1985 in London as the number of idled capesizes fell to almost zero, indicating strengthening demand for iron ore." The BDI measures the cost of shipping bulk commodities.

"Capesize rates have risen more than ninefold from a record low of $2,316 a day on Dec. 2. Steelmakers may be replenishing stocks in China after they fell 22 percent by mid-January from a record in September. Producers abroad, faced with an oversupply of iron ore, may also be shipping ore to China for storage."

This restocking of Chinese inventories is what BHP's Marius Kloppers referred to earlier this week. It wasn't exactly a silver-lining to an otherwise disappointing report. But it did remind us: someday this crisis is going to end.

Today is still not that day.

BHP's first-half net income was down 57%. Qantas' was down 66%. And now Macquarie Group reports it will take another $900 million in write-offs and impairment charges in the second half of the year, on top of the $1.1 billion it took in the first half. GE Capital is firing workers in Melbourne and Sydney and its chief executive Steve Sargent told investors yesterday that, "Australia is going to experience its credit crunch in the first half of this year."

Yikes. Or, if you prefer, daloob.

You might have thought the poor earnings performance that's coming to light during reporting season would have already been factored into Aussie share prices. After all, stocks were down nearly 50% last year. They are already down 7.5% in 2009. But then, perhaps investors were not prepared for the financial crisis moving off the share market and on to Main Street.

It's not much better over on Wall Street. The Dow Jones fell below 8,000 and investors pondered what it means that the head of America's Executive Branch of government is now dictating the salaries of Chief Executive Officers on Wall Street. President Obama announced that heads of financial firms receiving government bailout money would have their salaries capped at $500,000. More on that in a moment.

What about inflation? Where is it hiding? Gary North makes a good point in his e-mail newsletter yesterday. Gary shows that the American monetary base has doubled. But that increase in the money supply has not, so far, made it into the economy where the money multiplier kicks in. Why not?

The huge increase in money supply went to banks, who then parked the money right back at the Federal Reserve as "Excess Reserves." The banks took the money but didn't make the loans, terrified of not getting it back from borrowers. Those excess reserves pay a measly one percent interest. Meanwhile, the banks are paying out interest to depositors at between 2-3%.

Do you see the problem here? It can't go on forever. The banks are losing money on the spread between what the Fed pays on excess reserves and what they must pay to depositors, who are saving more. It is death by a thousand cuts. And now you have Obama and Congress promising to mandate new bank lending.

It means we could reach a tipping point sometime soon where the increase in the monetary base actually begins to make it into the economy in the form of new bank lending. Whether the banks do it because they're losing money on the spread or because they have to do it doesn't matter. They will probably do it.

And it doesn't really matter who the borrowers are. It could be the U.S. Treasury, who then goes on a cash splurge. It could be households refinancing 30-year fixed rate mortgages at 6% into 40-year fixed rate mortgages at 2%. It could be corporations, commercial real estate, private equity, you name it.

But be warned: if the doubling of the monetary base is finally unleased from the excess reserves held by banks at the Fed onto the economy, the money supply in the real economy is going to rise very quickly. Inflation will spread like wildfire.

For now, we have continued asset deflation. But policymakers in Washington may be lighting the fuse that forces banks to lend all that pent up liquidity the Fed has provided into the economy. With an increase in the money supply, prices will rise. It could be asset prices. Or it could be commodity prices like oil, energy, and gold. The general price level will rise very quickly.

Ben Bernanke is always worried about avoiding another Great Depression. The Friedman school of thought holds that the Fed's waited too long to cut rates and a liquidity crisis ensued as banks across the country failed. Money supply shrunk and the price level fell.

This time around, there is no liquidity crisis. Banks have plenty of reserves provided by the Fed. But those reserves are compromised by bad assets. That's why this has always been a solvency crisis, where banks had heavily leveraged balance sheets. On those balance sheets you had a thin slice of equity capital supporting a massive edifice of debt-backed assets.

It's anyone's guess how the assets are going to be handled by Geithner and Obama. But it will probably be a one-two punch of some sort. First, the assets are sold to the "Bad Bank." Next, some form of bank recapitalisation with taxpayer money will include language that requires banks to lend (especially in the commercial paper and residential mortgage markets).

Whatever you choose to call the times we live in, they certainly aren't boring. They are, of course, absurd. Take the case of Washington assuming a morally righteous tone and lecturing New York about fiduciary duties. Gag.

Here's a thought: if Washington can set salary caps on Wall Street because taxpayer money is involved, why can't the rest of America set salary caps on American legislators? Those clowns get government money every single day. They even spend money they don't have by robbing from generations of unborn Americans. And they've run regular structural budget deficits for decades!

Congress, the Fed, the President and the Treasury have mis-managed their institutions even more than Wall Street mismanaged itself. The political class (the world over) now represents its own interests above the interests of the electorate. How could you change that?

We are not normally in the business of offering constructive solutions to political problems. But we'll have a crack at it today. How about a rule that no one in serving in Congress is allowed to make more than the median household income, as determined by the U.S. Census bureau, until the Federal Budget is balanced?

In this new era of accountability, shouldn't everyone be accountable for how they discharge their responsibilities? If CEOs can have their pay capped (something shareholders ought to have done via the compensation committee, if they really cared) then why shouldn't Congressmen and Senators be performance managed by the taxpayers?

Or think of it this way a 19-year old U.S. Marine deployed overseas to a combat zone earns a base salary of about $1,400 per month, according to the Department of Defense. He makes an extra $225 per month in "combat pay" while he's deployed. If he's married, he gets $250 in "family separation pay" each month, too. If he's in Iraq, he gets another $100 in "hardship duty pay". And while in a combat zone, he won't have any withholdings of federal income tax.

He still can't drink a beer, of course (and not just because he might be in a country where that's prohibited). And if we're weighing up his total compensation versus his salary, let's not forget he's not paying for his meals or accommodation, which are assuredly first-class and five-star. Still, assuming he's in Iraq for a year and married, his grand total for the privilege of putting his life on the line on behalf of his country is a whopping US$23,700.

That's about half the median household income of $50,000, using the Census Bureau's figures. But it's considerably less than the $174,000 annual salary paid to rank-and-file members of the U.S. Congress. House Speaker Nancy Pelosi does a bit better at $223,500 per year. But she's probably a lot busier than most Congresscritters.

So let's do the maths. A 19-year old serving his country in Iraq can max out his salary at $23,700. But the people who declined to fulfil their Constitutional duty and properly declare that war in the first place make $174,000. And while making this handsome salary, they run regular annual budget deficits, often fail to pay their taxes correctly, and lecture the American people on the need for sacrifice and how "patriotic" it is to pay taxes.

Can you see why trust in public institutions has reached an all-time low? From 1789 to 1885, anyone lucky enough to serve in public office in Congress received a per diem salary of $6 and nothing else. Perhaps if we made all 535 members of the U.S. Congress live in the same dormitory and eat the same cafeteria food they'd actually spend a lot less time in Washington.

It would be a huge improvement for the nation and the quality of its laws. And if elected officials could make no more than those who put a uniform on for their country and risk death each day, maybe elected office would cease being a lucrative career objective and resume being something you did because you cared about your country.

However that is probably too quaint and earnest a sentiment for this publication. In fact, we're already embarrassed to have written it. Almost as embarrassed as we are by the spectacle of public officials plundering the future while we all just sit there and take it.

Dan Denning
for The Daily Reckoning Australia

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