In a free market economy, Fannie and Freddie might be allowed to go under. Investors and lenders would both suffer...but the economy would go on and be strengthened by getting rid of its nasty carbuncles and tumors. But this is not a free market. It is a market where the big players always seem to manage to get an edge for themselves. For example, since 2003, Wall Street paid out a quarter of a trillion in bonuses - most of it on dubious, debt-drenched transactions that were never completed. And then, when the debt goes bad, in comes the U.S. government to bail out the whole system. The Wall Street pros keep their bonuses, with not even a "thank you" to the feds.

Fannie and Freddie can't be allowed to go under - largely because their debt is held by foreigners. Don't get us wrong. The feds would love to stiff the foreigners. But they can't...not yet. The Chinese, for example, are the single largest lenders to U.S. government agencies - including Fannie and Freddie. And the feds desperately need that flow of juice from the Far East to continue. So Henry Paulson came up with what is known as the "Paulson Doctrine" - we'll let the stockholders take a loss, but not the bondholders.

The Paulson Doctrine will hold until it is no longer needed. When will that be? We'll tell you - the foreigners will lose their money when inflation has already turned them against more dollar credits. That is, when inflation has finally convinced them to dump the dollar and refuse to lend more to U.S. government agencies, the feds will have no further use for foreign lenders. Then, they will turn their backs on the Paulson Doctrine and stick it to foreign dollar holders hard.

Bill Bonner
for The Daily Reckoning Australia

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• The Fog of the ’Flationary War is Lifting
• Fannie and Freddie Say Goodbye to Veto