And today we take up a foul and disagreeable task. We ask ourselves: what if we are wrong?

If you bought gold when we first recommended it, ten years ago, you are in a very comfortable position. Gold sells for more than 4 times as much today. But what should you do now? And what if you didn't go for broke on gold in the early '00s? Is it too late to get in on the bull market?

To give you a warning, in the following windy ambulation we come to no conclusion we haven't come to before. We say gold is going to the moon. If we are wrong about when...we will be delighted sooner than expected...self-satisfied...and insufferable for years. If we are right, we may have to wait a long time before saying "I told you so."

First, the press has certainly noticed the bull market in gold. How could it not? Most reporters say gold is going up simply because the dollar is going down. In the popular press, we found no other explanation. In fact, much of the notice of gold seems to occur within articles about the dollar. We found, for example, that the dollar is at a 15 month low...and, coincidentally, gold has just hit an all-time high.

There's something lopsided about this account of things. If the yellow metal has hit a record high, how come the dollar is down for only 15 months and not since the Flood? Makes you wonder if the dollar isn't the whole story.

Elsewhere, we find that the dollar is trading at $1.49 per euro. Wait a minute. We remember the dollar at the exact same level...was it a year ago...more...? And it's been at that same level, more or less, all the while gold has gone up more than 10%.

It's not the fall of the dollar that is driving the gold market, in other words, it's something else...it's the fall of ALL paper currencies. For when the dollar goes down, so do the rest of them - more or less. No nation wants its currency to rise too much against the greenback. Americans are still the world's biggest spenders. They spend dollars...not rubles...not euros...not zloties. A nation whose currency rises against the dollar is in a competitively weaker position. Its costs - in local currency - go up while its sales - in dollars - go down (it has to charge higher prices). Typically, central banks buy up dollars with money created for that purpose...thus increasing their own money supply and thus decreasing the value of their own local currencies relative to the dollar.

Since all the world's central banks, more or less, are doing this, all paper currencies are going down together - compared to gold.

But wait, wouldn't they be going down together against everything else too? If currencies are getting weaker...shouldn't they be getting weaker against oil...and McDonalds' hamburgers...and woolen underwear? The oil price is at $78 - where it's been stuck for a while. Oil is a special case, but almost all consumer prices are stuck too. Take out energy and food, and consumer prices are deflating in the US. Put back in the energy and food and they're just stuck. There is no sign of generalized consumer inflation - not in the USA and not in Europe either.

The only thing that is going up is gold. There is a bull market in gold and gold alone. But why?

According to the law of supply and demand, you expect the price of a thing to fall when its supply increases faster than the demand for it. In today's news are two reports on gold production. One, from South Africa, tells that a scientist says the nation's residual gold in-the- ground is much less than expected. It has been overstated by 900%, he says. Another report shows the output of from the gold mining industry clearly topping out. Gold supply, in other words, is increasing, but not as fast as it used to.

The supply of paper money, on the other hand, needs no new discoveries. Since there have been huge increases in the monetary base of paper money all over the world, it is reasonable to expect the price of paper money to go down. Gold, traditionally the thing that paper money is priced in, should go up. Speculators are buying it now in anticipation. Even central banks are buying again. And nearly everyone expects the price to continue going up.

As near as we can tell, gold is properly priced already. Comparisons are rough, but an ounce of it appears to buy about as much stuff as it did 2,000 years ago. You can buy a suit of clothes for an ounce of gold - no problem. Go to Wal-Mart; you can buy 4 suits.

As Roy W. Jastram wrote in his 1977 book, The Golden Constant, gold's "price has been remarkably similar for centuries at a time. Its purchasing power in the middle of the twentieth century was very nearly the same as in the midst of the seventeenth century."

Gold...or the people who speculate in it...may be looking ahead. Or, they are dreaming. If gold is already about where it should be why would you pay more? You must expect paper currencies to go down...to buy less stuff. In other words, you'd have to be anticipating a fall- off in the value of the paper currency.

It may come to pass exactly as they imagine it. Gold may rise and rise and rise...as paper currencies fall and fall and fall some more. In that case, we here at The Daily Reckoning headquarters as well as all of our dear readers who followed our advice 10 years ago will be delighted. Gold may hit $1,500 by the end of the year. By the end of next year it may be $3,000. By the year after, well...who knows...? "We told you so," we will say.

But there is almost always more under Heaven than speculators think. When we look into it, we see gaudy increases in the monetary base...but only very modest increases in M2, the money that buys stuff. What's more the rate of increase for M2 has fallen in half over the last 8 months. It's now only about 7% annually in the US. And when we look at the CPI we see no increase at all. And despite the 'recovery,' unemployment is still rising and house prices are still falling. So, if speculators see the price of stuff going up in paper currency terms, they must be looking way over our heads.

To more fully describe our own state of mind, we don't doubt that all the liquidity added to the world's monetary system will eventually be soaked up by paper currencies. But it could take a long time; we might be dead before it actually happens.

But since we are entertaining the possibility that we might be wrong; let us look at what is going on in more detail. If there were a real recovery - as announced in the world's newspapers and proclaimed by its stock markets - you'd expect a rising increase in demand...leading to higher prices...leading to a higher gold price.

Yesterday's news brought word of greater retail spending than anticipated. This was greeted as more evidence that a recovery is actually underway. But upon examination, we discover that the evidence comes almost all from auto sales. We also find that the number crunchers contributed to the lift by revising figures for September. These are month to month movement numbers. So you can raise October's number simply by lowering the number for September.

What's more, while sales went up...auto prices actually went down - in paper dollar terms. This doesn't sound inflationary to us.

Meanwhile, news reports said that fewer people are defaulting on credit card debt. The reports also tell us that delinquencies on credit card debt are up. So, we'd have to call that a draw.

And then there's the news from GM. The giant, government-owned auto company says it will repay its loans from the feds earlier than expected. But wait...we also find that the company continues to lose money. How then will it repay debt? Perhaps by refinancing!

Other reports are similarly confusing and inconclusive. Profits are up on Wall Street. But wait...sales are down. You can increase profits by cutting expenses (getting rid of employees, mainly). But you can't increase sales. And as long as sales are falling you have to expect lower profits in the future. (Stock market buyers...take note.)

Our colleagues over at The 5-Min. Forecast sent through this chart, illustrating the "recovery that wasn't."

"With the majority of publicly traded companies done reporting third quarter earnings," writes 5 editor, Ian Mathias, "the trend is clear: Profits were way better than expected, revenue was flat at best.

"Of what little we recall from freshman year, Finance 101 insists that profit equals revenue minus costs. Thus there really can't be any questions left as to how the market pulled off this quarter...companies are simply trimming the fat at an incredible clip. Not exactly a long- term plan for growth."

The New York Times reports that job losses continue to be "deep and enduring." Mortgage applications are running lower than they were 9 years ago. "More households report food shortages," says a Wall Street Journal headline. And insiders are still selling their own companies.

So, it still looks to us as if we are in a depression...one that will take many years to sort out. It is unlikely that the bull market in gold will reach its final blow-off top while the depression continues. But stranger things have happened. Eventually, gold will reach the apogee of its bull market. And when it does, we want to be ready for it. We will celebrate with champagne and sparklers.

Still, we wouldn't get out the party hats...not just yet.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Gold is in a Bull Market
• We are Confident the Bull Market in Gold is Not Over
• Investors to Drive Next Leg of Bull Market in Gold
• What Happens to Gold When High Inflation, Excess Cash, and Falling Dollar Jolts Economy?
• A Gold Standard, Without Gold

Two important things happened yesterday, both of which cast a crimson light on things.

First, the Dow dropped again; it has only gone up one of the last 7 days. It went down 203 points. Could be nothing. Could be something big...the beginning of the long awaited 'next leg down' for the bear market...the opening day of a bloody Red October.

Charts of oil, commodities, copper, the dollar, and Treasury bonds tell us the same story. The greed investments are topping out. The fear investments are headed up.

What's a 'greed investment?' It's anything that benefits from an improving outlook for the economy and inflation - oil, commodities, and stocks, mainly.

What's a 'fear investment?' It's something that goes up when people begin to suspect the boom is a phony - namely the dollar and US Treasury bonds.

The dollar is rising. So are Treasuries. Yesterday, 30-year US Treasury bond yields fell below 4% for the first time since April.

And what about gold?

Well, that's the other important thing that happened yesterday. Gold held above $1,000.

So what?

So what?? Well, dear reader, you are in a prickly mood this morning, aren't you?

This is important because gold could go either way. Gold is a refuge in times of fear - especially when people fear inflation or a falling dollar. Gold is also a target of greedy speculators sometimes, even when the going is good. According to a study done by the World Gold Council, you never know what gold will do. That study was a great comfort to us here at The Daily Reckoning; we thought we might have missed something. But no. We may not know what gold will do, but neither does anyone else.

Looking around, we see no sign of consumer price inflation. So gold's recent rise must have been driven by optimistic speculation - along with oil and stocks. Now, when oil and stocks go down... we have to wonder whether gold will go down too. The answer, given yesterday, was what we expected - yes, but not as much.

There's substantial risk in gold as well as stocks. The ultimate low for the Dow should be below 5,000. That is, let's say, about a 50% haircut from current levels. And let's assume that gold does what it did yesterday...let's suppose that it goes down only 40% as much as stocks. That would still be a drop of 50% of 40%, or 20% - to the $800- an-ounce level.

If you would be gravely upset by a drop of that magnitude...you probably shouldn't buy gold at this level. And, of course, you should have sold your stocks already. Stick to cash - and gold, if you're long-term oriented - until this next phase is over.

The economic news was mixed, as usual...with nothing to make us think that our basic outlook is wrong.

On the optimistic, bullish side...consumer spending rose in August. Pending homes sales went up too.

But on the pessimistic, bearish side... "September auto sales plunge," says a Reuters headline. Yes, auto sales drove off a cliff last month - just like we said they would. GM reported a 47% drop.

What happened? The clunkers program was an economic fraud. Like all attempts to boost consumption, it merely shifted sales from the future to the present (now the past). Which is a big reason why August consumer spending looked good too.

But wait a few weeks for the September consumer spending numbers. Especially if the stock market continues to fall... Then we'll find out how sustainable those retail sales numbers really are.

As you know, here at The Daily Reckoning headquarters...in the building with the gold balls on the south side of the Thames...we are often accused of 'pessimism.' We deny it. We're optimistic about the fate of mankind. But we are pessimistic about many of his current pretensions - such as health food, enlightened central banking, contemporary art, mass education, global climate control and progressive democratic government.

But maybe we are wrong to be optimists. Pessimists always have the last laugh - when the optimists die. "I told you so," they say, under their last breath.

Bill Bonner
for The Daily Reckoning Australia

• Is Gold Going Up Because People Fear Inflation?
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Abandoned Shopping Malls to Follow Abandoned Houses
• China Stepping Up Purchases of U.S. Treasury Debt
• September is the Best Month for Gold

Let's review our own narrative: deflation now, inflation later.

It's very simple. Maybe too simple. After a half a century of credit expansion, we now have a credit contraction. In this sense, everything is happening as it should.

There was a crash and credit crunch at the end of last year. Then, the feds panicked. They fought back with monetary and fiscal stimulus. Rates were cut to nearly zero. The Fed flooded the system with cash and easy credit - buying up Wall Street's bad investments...propping up bad banks...and guaranteeing trillions worth of bad debt. And the federal government passed a stimulus program that authorized more than $700 billion in spending.

Beginning on March 9th, we also got a big bounce in the world's stock markets - just as we should. US stocks are up about 40% since then. Some foreign markets are up even more. Russian stocks, for example, have more than doubled. Chinese stocks are up more than 60%.

As the bounce continued, people began to get the wrong idea. They thought they saw 'green shoots' and the 'light at the end of the tunnel.' But if the economy is really improving, we haven't seen much evidence of it here at The Daily Reckoning headquarters. As near as we can tell, housing prices are still going down and unemployment is still going up...and most important...people are still acting as though we were on the downward slope of the credit cycle. The latest numbers we've seen show that they saved more money in the first half of the year than the total in extra 'stimulus' that they received. Savings - last reported at 5% in this space - are now close to 7%. This is a just what you'd expect. But it is a huge turnaround, too.

As to housing prices, there are a million option ARMs still to be reset over the next four years. They won't peak out until 2011...with average increases of about 80%. That will cause hundreds of thousands more houses to be dumped onto the market...and probably push the bottom of the housing decline to 2012.

As long as housing prices are falling, jobs are declining, and consumers are inclined to save rather than spend, there will be no real recovery.

In our book, recovery is impossible anyway. Because the pre-crisis economy had reached the terminal stages of the credit cycle. It was like someone in the terminal stages of a fatal illness. After they have died, you don't wish that they could recover...and be just like they were before they died. They were sick and dying then! No, you sign the book of memories and condolences and turn the page. You let new life take the place of the dead. You move on.

But the feds have their ghoulish agenda. They have the poor thing on life-support. One tube feeds the oxygen of easy credit. Another drips in more 'stimulus.' The economy rattles every time it breathes. Dead companies, such as GM, say they are reborn. But take away the tubes...and they collapse. Dead-in-the-water households learn to live submerged in debt ...with special tubes provided by the feds - such as the underwater mortgage refinancing offered by Fannie and Freddie, where homeowners can get up to 125% of the value of their houses. And the brain dead economists at the Fed and the Treasury department continue to offer their elixirs and panaceas - even though they have never worked.

Everything is happening as it should, in other words. But what happens next?

Ah...this is where it gets tough. Because we're losing our faith. We figured the economy would continue to worsen (after all, you can't correct a half-century credit expansion in a few months)...and that the feds would continue to fight it. As more and more people lose their jobs, the feds would become more and more desperate. Gradually, they'd come to see that they needed to use stronger, more experimental techniques. This would lead them to be a bit bolder with their 'quantitative easing,' otherwise known as "a little technology called the printing press," to quote Ben Bernanke.

We figured that sooner or later, the feds would get the hang of causing inflation. So, we could just buy gold and wait.

But now we see; we are trapped...just like the feds themselves. Do we hedge against further economic deterioration... deflation... and falling asset prices? Or do we hedge against inflation...a falling dollar...and a collapsing bond market? What if we hold our big position in gold...and feds NEVER are able to cause inflation? What if the pain of the depression is never severe enough to make them go whole hog on quantitative easing? What if the Chinese put it to them straight: if M2 goes up more than 10% a year...we stop financing your deficits? Gold could sink...or go nowhere...for the next 10 years.

Are we prepared to sit it out...? It's time to go back to the pub...

This morning our thoughts turn to Goldman.

The news yesterday told us that Goldman execs paid themselves $700 million in bonuses - while receiving bailout money. This morning, stocks in Asia are rising; they say it's because Goldman had a good quarter - wiping out its loss from the last quarter of last year...

The news:

"Goldman Sachs reported second quarter earnings of $2.72 billion, up on last year's $2.05 billion, and easily surpassing forecasts thanks to big gains in trading and underwriting."

The New York Times offers more details:

"Analysts estimate that the bank will set aside enough money to pay a total of $18 billion in compensation and benefits this year to its 28,000 employees, or more than $600,000 an employee. Top producers stand to earn millions.

"Goldman Sachs is betting on the markets, but the markets are also betting on Goldman: Its share price has soared 68 percent this year, closing at $141.87 on Friday. The stock is still well off its record high of $250.70, reached in 2007.

"In essence, Goldman has managed to do again what it has always done so well: embrace risks that its rivals feared to take and, for the most part, manage those risks better than its rivals dreamed possible.

"For all its success, Goldman is not impregnable. In addition to the federal money it took last fall, it benefited from the government's bailout of the American International Group, being paid 100 cents on the dollar for its $13 billion counterparty exposure to the insurer, and it has $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corporation."

Not everybody likes a winner. There are some who think there is something underhanded and un-American about how Goldman does business. Making billions trading bonds? It is almost as if they knew better than anyone else what the feds would do next. Maybe they do.

The DR Australia's Dan Denning offers his two cents on the subject:

"We'd suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America." Furthermore, Denning points out, most other American financial institutions are continuing to play "hide the bad asset."

"A New York Times story suggests that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble.

"'The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,' says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. 'It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.'

"This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now," Denning continues. "The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they'd get a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent)...

"The default and foreclosure data coming out of the US housing market suggest the banks are kidding themselves, or misleading shareholders, or both!" says Denning. "It's the sort of calculated mistruth that can cause a short-term crisis to last years and years. The correction is postponed through phony accounting. It leads to an 'Ushinawareta Junene,' or 'lost decade,' as the Japanese say."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Have the Feds Given the Economy a Miracle Drug?
• Hiding Level Three Assets Won’t Solve the Problem
• Feds’ Plan is to Reflate the Economy
• Economy Free to Recover?
• Level 3 Assets Growing in All Five U.S. Investment Banks

In the month of May, Japan's exports declined 40% year on year.

Yesterday came similar news from Europe. Industrial orders in the Eurozone dropped 35% in April, from the year before.

"Fed on hold as slump eases," reports The Wall Street Journal. What exactly is meant by 'slump eases' is unclear. As near as we can tell, the slump is getting worse.

"New home sales plunged 32.8%." Bloomberg reports that house prices in California and Las Vegas are being hit hard by a wave of foreclosed properties. Yes, dear reader, the anklebone is still connected to the leg bone.

Bloomberg also reports, "jobless claims are up."

A fellow loses his job; he can't pay his mortgage. The house goes onto the market and pushes down prices. Prices in California are off 30% year-to-year, with the median house at $267,000. In Las Vegas, the median house is only $135,000 with 75% of sold properties coming from foreclosures.

The housing market is slow. But it works like other markets. It reacts...then, it over-reacts. It shoots. Then, it over-shoots. One study we saw said that housing prices were now down to "reasonable" levels. But there's no law that says they can't go to unreasonable levels. They were very unreasonable two years ago; they're likely to be very unreasonable in the other direction before this depression is over. Hold on; maybe you'll be able to get the median house in California for $199,000.

The WSJ notices that the leg bone is connected to the knee bone too, "house price falls are cutting into economy," it says.

Well, what did you expect? That's what house price declines do. People feel poorer because they are poorer. And with no source of ready cash - they spend less. Then...the whole economy weakens...etc....etc.

We've been over that enough times already. You don't want to hear it again.

And remember how we warned of a big increase in credit card defaults? When the slump began...and consumers could no longer "take out equity" from their houses...they turned to credit cards to fill the gaps in household budgets. Since then, there has been no increase in household earnings. To the contrary, household earnings have gone down. So the fellow with more credit card debt and less revenue is in a predictable jam. What does he do? He defaults.

"Credit card delinquencies at record," says one headline.

"Credit card charge offs break record," says another.

And these aren't the only kind of defaults the United States will be bracing itself for. A second wave of mortgage loan defaults is headed this way. Batten down the hatches and otherwise prepare...once it hits these shores, it will likely do much more damage than the first wave.

Elsewhere in the news, we find GM closing plants and Ford cutting out half its suppliers.

Yes, the Fed is on hold. It dares not do anything else. Its voodoo revival program has not worked. The corpse of the real world economy is as lifeless as ever.

What will it do next? We wait to find out.

And poor Michael Jackson: RIP.

Bill Bonner
for The Daily Reckoning Australia

• Australian House Prices Are Severely and Seriously Unaffordable
• New Default Wave Hits Mortgage Industry
• California Has Run Out of Money
• House Prices Down and Aussie Market Enters Second Wave of Rebound Rally
• Australian Credit Card Debt Grew by 9% in February

What if the rally is over? Could be...it began on March 9th. That makes it more than three months old. Most likely, it will continue through the summer. But who knows?

The important thing to remember is this:

There can be no major, sustained bull market without one of two things happening.

Either the mistakes of the Bubble Epoque must be cleared away...allowing for a new era of genuine growth and real prosperity. At best, this would take a few years to achieve. Just imagine how long it will take to restructure GM into a profit-making business again. Just imagine how long it will take consumers to pay down their debts so they can begin to spend again. Just imagine how long it will take to save enough money to build new factories...and convert shopping malls to warehouses and apartment complexes... And just imagine how long it will take with the feds fighting it tooth and nail. At least a decade!

Or people must be willing to go even further into debt...thus increasing the errors of the debt-soaked boom. Anything is possible. But here at The Daily Reckoning we think the economy is already saturated with debt. It can't absorb more. Besides, the financial industry is no longer capable of pushing debt on the public. That machine is broken. The bubble in finance exploded when Lehman Bros. went down. Once a bubble blows up, it can't be reflated.

And so far, the feds' efforts to reflate the bubble in consumer finance have caused a return of speculation in oil, commodities, and emerging markets. There is no sign of consumer price inflation or expanding consumer credit. Instead, consumer credit is contracting.

So don't expect a real bull market.

Instead, let's move on...this just in:

The Financial Times reports that a vending machine company is soon to install machines in Germany where you'll be able to buy gold as easily as buying a chocolate bar. There's one machine already in the Frankfurt Airport, where for 30 euros you can buy a 1-gram wafer of gold.

Already, in Switzerland, you can buy gold in the post office.

What do these yodelers and sausage eaters know that we don't? Germany was required to pay reparations after WWI. The amount was about $1.121 trillion in today's money. In gold. She had no choice. She had to turn over her real money - gold - to the victorious French and English. Thus, she had no real money left in the domestic economy. What could she do? Germany printed up marks...not backed by gold and experienced hyperinflation, up close, in the '20s. Coming not long after the debacle of WWI and the Treaty of Versailles, it not only destroyed the economy...it also wiped out savers and destroyed Germans' residual faith in their own sausages. Soon after, there were armed gangs of communists and national socialists fighting for control of the streets. And we all know how that turned out...

So, back to the U.S.A.: The United States has entered the third and final stage in the life and death of a great country.

America's history can be divided into three broad stages. The first stage was industrialization. This is what took the United States from a marginal nation of settlers, explorers, farmers, entrepreneurs and religious refugees to become the world's richest and most powerful country. The source of its wealth and power was its factories...and its people. The factories were the best in the world. And the people how labored in them were accustomed to hard work, saving, and self-
discipline. There were no free lunches in America during this period. The fastest growing cities of the time were manufacturing centers - Chicago, Gary, Detroit, Pittsburg, and Birmingham. Thanks to its smokestacks and assembly lines, the US could make things better, cheaper and faster than any other country, with the possible exception of Germany before WWI and Japan after WWII. That is how the US became the world's largest creditor - by selling US-made goods to foreigners. And it's how the United States won WWI and WWII too. American factories could turn out more tanks, more planes, more guns and more butter than any other nation. And the United States had an abundant source of fuel too; "Texas Tea" they called it.

After WWII America enjoyed its glory days. It was on top of the world...in practically every sense. The United States was #1.

Nothing fails like success. The New Deal had fundamentally changed Americans' relationship to the state. Federal meddlers began playing a larger and larger role in the economic life of the country. Soon, American attitudes evolved to fit the circumstances. With the world's reserve currency...a huge lead over its competitors...and a government that promised to take care of its wants and needs, the US workforce relaxed. Gradually, it shifted from making things to buying them...while industry turned its focus from production to sales...and then, financing. Then, the United States entered the second stage: financialization.

In this second stage, the center of gravity shifted from the wealth-
producing factories to the financial centers - mainly Manhattan. Prices of real estate in New York soared. Wall Street came to be seen not merely as a place to invest the proceeds of honest toil...but a way to create wealth. The most ambitious college graduates turned from engineering and manufacturing first to sales and marketing and later to finance; because that's where the money was. At the peak, in the Bubble Epoch, 2003-2007, Wall Street was drawing in the world's leading scholars in mathematics and statistics... These people were creating the biggest debt bombs in history...exotic, complicated financial concoctions...that eventually blew up in their faces.

Detroit went into a decline as early as the late '60s. GM continued to make cars, but it looked to financing as a way of make money. GMAC became the major source of GM's profits. Still mills along the Monongahela River began to rust in the '70s. Ships began to come to the US laden with goods in the '80s and '90s...and to go back empty. The US Fed tried to stimulate the US economy on several occasions, but it had a strange effect. It put more credit in the hands of US consumers - who used the money to buy goods from overseas. In effect, the US Fed was stimulating manufacturing in China!

But in 2007-2008 the bubble in consumer debt blew up. GM went broke in May of '09. The financialization stage ended. In its place comes a new stage: politicization, the third and fatal phase of a great nation.

Where is the money now? It took the train from Grand Central Station in Manhattan down to Union Station in Washington, DC. Want money? Ask Washington. It's pledged an amount equal to three times what it spent in WWII to the fight against deflation.

Where is the power now? Just ask Chrysler bondholders; in the end it didn't matter what their contracts said...when the US government turned against them, their goose was cooked. The Obama Administration, owner of GM, now sets top salaries and determines what kind of cars the company will make. Washington also determines which businesses will be kept alive - AIG - and which will die - Lehman Bros. Now it's the politicians, not Wall Street, nor investors, who decide the allocation of big capital...

And when ambitious young people buy a ticket to begin their careers, are they going to Milwaukee...to Manhattan...or to the lobbyists' mecca in Northern Virginia?

Bill Bonner
for The Daily Reckoning Australia

• Hyper-Deflation on the Streets of Paris
• The Codependent Relationship Between China and the United States
• A Golden Success Story from the Solomon Islands
• Roasting G-20 Weenies on a Golden Spit
• “All the World is a Stage…”

Last year, London had a beautiful summer too. But we were gone that week and missed it.

Alas, many of the best things in life are fleeting. And thankfully, so are the worst things.

What put us in such a reflective mood were yesterday's news reports. The Dow rose again - up 19 points this time. Gold edged closer to the $1,000 mark - at $984. Oil traded at $68. And the dollar fell to only $1.43 against the euro.

These trends - not to mention the broad rise in commodities and stocks worldwide - lead many investors to think that the fair weather is back, permanently. Asset prices are rising. Investors are less afraid of risk. Hallelujah - a dove with a sprig of green in its beak!

Of course, it may be true. But our advice, dear reader, is to take an umbrella with you anyway. As far as we can tell, nothing has happened to disturb the major weather pattern that began developing two years ago. Anyone could see it coming years in advance. "You gotta expect trouble when the average house is more expensive than the average person can afford," we kept saying.

But it was only when high winds hit the housing market that the newspapers took notice. Then, for 40 days and 40 nights the rain came down.

First, the house flippers were caught off guard. They were in the middle of flipping condos when all of a sudden the wind shifted and sent their contracts aloft. Mortgage rates were rising and buyers disappeared. The flippers lost their deposits and walked away from empty buildings.

Then, resets and higher rates blew the roof off the subprime market.

Then, the whole housing sector was getting knocked down - builders, suppliers, and financers.

Next came the credit crunch...when major lenders and investment banks realized that they were in heavy seas. Their ships were swamped with mortgage-backed debt and derivatives...and their captains were morons. Lehman went down. Wall Street abandoned ship. And the feds sent out rescue planes.

By late in 2008, everyone was taking shelter. Businesses were cutting payrolls. Banks were squeezing their reserves. Consumers were staying at home. And GM was hiring bankruptcy lawyers.

Everything was falling in price - houses, office buildings, stocks, commodities...practically everything except the US dollar, US bonds, and gold... These three were seen as the only safe refuges for storm- tossed investors.

But on March 9, 2009, came a lull. Reluctantly, investors came out of their storm shelters. The skies lightened...the sun shined. Oil has gone up 53% since then. Stocks worldwide are up about 30%.

And now...people say "the worst is behind us."

We meteorologists here at The Daily Reckoning watch the skies like everyone else. But we also read reports from big storms of the past. And what we notice is that this doesn't look like the passing storms of the '80s or '90s. It looks to us like a major change in weather patterns. To be more precise, it looks to us like the Great Storm of the '30s. Do you remember that one, dear reader? No? Well, we don't either, but we've read the histories. It was a doozy. And it began...well...just like this one.

In 1930, six months after the initial storm front passed, world output was down about 15%. Today, it is down about 15%, too. Stock markets were only down about 20% in mid-1930. Today, they're down about 35%. And world trade slipped about 15% in the six months following the onset of the Great Crash of '29. Today, it is down 25%.

One thing you notice is that like the Great Depression, this downturn is global. A collapse in world trade followed the Crash of '29. It is usually blamed on two protectionist bumblers in Congress - Smoot and Hawley. But in a real depression, trade falls anyway. World commerce needs to readjust to new realities...whatever they are. That's happening again now.

The other thing you notice is that this adjustment takes time...and takes the losses much further...much deeper...than anyone expects. The actual bottom in the '30s didn't come until 2 to 3 years after the crash. And it took stocks all over the planet down to about 65% below their peaks. World output eventually fell to only about 2/3rds of what it had been in the late '20s.

It took two decades and a major world war before the world was back on its feet.

Bill Bonner
for The Daily Reckoning Australia

• Hidden Inventory of Unsold Houses Will Depress Housing Prices
• Who’s Afraid of a Financial Meltdown?
• Investors in China Have Learned Nothing From the Crash of ‘07-’08
• Investors’ Objective: To Make Money
• Come And Get It!

Actually, we've seen so much already that it's hard to believe there's more coming. But there's sure to be more...and we have a feeling it will be worth the wait.

Yesterday, for example, GM filed for Chapter 11 bankruptcy protection. It couldn't pay its bills. GM was once the strongest corporation on the planet. But it has been around for nearly 100 years. Heck, everything wears out eventually...even a '55 Chevy.

"Obama Nationalizes GM," says a triumphant headline in France's La Tribune.

Triumphant?

Yes, according to the papers, Obama may have been handed the keys to GM...but the old jalopy is worn out. The French say the whole US economic model is ready for the junkyard. More on the French...and the French model, in our other article....

First, let's stick with the USA.

The Dow rose 221 points yesterday - to 8,821... Investors think the worst is over.

Everything is going up. Copper is up 65% so far this year. Oil is up 53%. Soybeans are up 22%. Stock markets are up about 30% worldwide. And gold is 12%. In this company gold is a laggard!

Copper has risen so much, say the papers, because China is buying all it can get. What it is doing with the stuff we don't know; maybe it is stocking up at what it believes are low prices.

Maybe it is hedging its bets. China has the biggest pile of Treasury bonds in the world - $768 billion of them. That's 768 billion reasons to worry. Because each T-bond is denominated in dollars...and while everything else is going up, dollars are going down. Yesterday, the dollar touched a new low against the euro for this year - at $1.42.

T-bonds are down too - minus 5% for the year. It would not be at all surprising for the Chinese to be stockpiling oil, gold, copper and all the other inflation hedges they can get. Their dollar-denominated bonds may go down...but their commodities and gold would go up. Overall, they'd come out even. You can also hedge your own nest egg with commodities.

Yet this week, Mr. Tim Geithner - the big banks' main man in Washington - is in China trying to reassure the Chinese that America takes its financial obligations seriously. That's something we never expected to see either. America may have the strongest economy on earth. But if the commies stop financing it, we're out of business.

So Geithner is in China, hat in hand, like a major debtor called into the bank president's office. Geithner, of course, has no choice. He has to go...and say what he has to say. He will use all the right words. He will show the appropriate seriousness...he will smile when it is called for...and put on a grave face when he needs to.

The trouble is, there's little he can do to help the Chinese. They want him to protect the dollar and the bond market. That's something he can't do.

"It will be helpful if Mr. Geithner can show us some arithmetic," said Yu Yongding, a former advisor to the Chinese central bank.

Yes, we'd like to see that arithmetic too. How do you add $1.75 trillion in deficits...pay for it with funny money from the Fed...and still come out even on the value of the dollar? There's no arithmetic we know of that works in the Chinese favor. Right now, the numbers...and the logic of the situation...are telling us that feds aim to create inflation. Instead of trying to keep prices under control...they're trying to get them to go up. That's yet another thing we didn't expect to see!

The US government is less concerned with protecting foreign lenders than it is with getting the US economy back to its old E-Z money ways. Cheap money is what people want. Cheap money is what the feds are trying to give them.

Today - will wonders never cease! - the US is pushing its phony money all over the world. The Chinese, meanwhile, are champions of financial integrity. Just wait until they give up on US bonds...then, we'll really see something we ain't seen yet!

Bill Bonner
for The Daily Reckoning Australia

• The Chinese and the Fed Both Buying U.S. Treasury Bonds
• American Family’s Share of Government Debt Now Over Half a Million Dollars
• Country Has Moved Towards More Government Intervention in Economy
• French Model of Economy Allows Meddling from the State
• China Has Stopped Stockpiling Metals

• Uncle Sam gets a 60% stake. The government will pump an additional $30 billion into GM (on top of the $20 billion already squandered). In exchange, the government will be the largest shareholder... leverage it will use to usher GM through bankruptcy and convert it to this "leaner, stronger company" we've been promised
• Half of the UAW's $20 billion health care fund will be converted to GM stock, which will give it a 17.5% stake in the company. 12-20 factories will be closed, at the cost of approximately 21,000 union workers. 40% of the 6,000 GM dealers will have to close, too
• The Canadian government gets a 12% stake, given all GM's design/manufacturing activity up north
• Bondholders were bought (bullied?) out. They'll swap their $27.1 billion in unsecured debt for 10% of GM, with warrants to own 15% more. Surely, they learned from Chrysler's bondholders, who were publicly vilified by President Obama for demanding what was lawfully theirs... so much for that hallmark of American capitalism
• Current shareholders get nada. At least that rule of bankruptcy is still intact. If you were long GM, please consider letting someone else manage your money. Anyone.

"GM Bankruptcy to Bring Taxpayer Ownership," headlined Bloomberg this morning. Shame on them and the US government for perpetuating this "taxpayer ownership" BS.

We must have been asleep when the "taxpayer" got any say in this one. GM is owned by wealthy politicians in Washington who, under threat of imprisonment, forced their constituents to finance the deal. Insinuating the public has any control is "Orwellian in the extreme" Addison suggested when we discussed the matter late Friday. Amen.

And let's be really honest... taxes haven't gone up to cover the GM bailout (or any credit crisis expense), but government borrowing certainly has. If any "taxpayers" truly own GM, their tax returns get mailed to Beijing and Tokyo.

Sign of the times... GM and Citigroup are getting kicked off the Dow. Cisco and Travelers will replace them next Monday. Extra irony (and foreshadowing?) in this exchange, as Citigroup is the former owner of Travelers, which it spun off in 2002.

The market had baked in GM's insolvency a long time ago. In fact, the Dow's off to the races this morning, even though one of its 30 components is rapidly approaching zero (the "beauty" of a weighted index). The big indexes rose 2% within the first 30 minutes of trading.

Ian Mathias
for The Daily Reckoning Australia

• Deal With Bondholders Cleared the Way for GM Bankruptcy
• The Chinese Stimulus Plan to Save the World
• Dow Jones Has Worst June Since Great Depression, American Model in Decline
• Obama Has Business Plan for the Car Industry
• Inflation Hasn’t Yet Reached the Wild Levels of the 70s

"You're just graduating from college, right?

"You wanna make some real money?

"Then, rush to Detroit. Set up a law firm specializing in bankruptcy."

More advice to college graduates follows...(below)...

Two auto-parts suppliers have already filed under Chapter 11. GM is expected to do so momentarily.

Too bad about GM. It was set up in 1916. If it had been able to hold together for another 7 years, it would have gone 100 years without having to declare bankruptcy.

All people die. All companies die, too. That's why 'buy and hold' is wishful thinking. Buy and hold long enough and you are sure to go broke. And die.

Eventually the undertakers and bankruptcy lawyers get you. And today...business is good in Detroit. What cleared the way for the GM bankruptcy was a deal with the bondholders...in which they take equity in exchange for their debt and agree not to contest the bankruptcy filing. Still, the deal - and other deals relating to it...including the presence of one very big and very odd shareholder, the government of the United States of America - is so complicated, it's bound to give bankruptcy lawyers plenty of work for many years.

But business seems to be picking up everywhere...at least, that's the impression you get from reading the paper. The war against capitalism seems to be going pretty well, in other words.

Yesterday, the rally continued on Wall Street, with the Dow up 103 points. Oil rose too. It is trading at $65 a barrel this morning. And look at gold - the old yellow metal is at $963 and still going up.

Does this mean the feds are winning the war?

"Signs of life return to California market," says the Financial Times.

Houses in many areas are selling for 60% less than they did two years ago. Two years ago, the average family couldn't come close to buying the average house. In didn't take a genius to figure out that that couldn't last. Who were they going to sell the average house to if not to the average family? Well, now the $600,000 dump from '07 has been foreclosed and is now on sale for $200,000. That means that the average family that still has a job can buy it.

And it doesn't hurt that the feds make it easier - distorting the market with an $8,000 tax credit and EZ financing from the FHA.

Wait a minute! Wasn't it easy financing that got us into this mess? Of course it was. But that little insight doesn't stop the feds. They're convinced that if they can just put out enough new credit, it will somehow make the problems caused by having too much credit before go away.

So here's the deal. You can get the FHA to finance a house, long-term, at just 4.9%. That's just 0.3% higher than the long-term Treasury yield. Even without opening the closet door, we smell a rat. How can lenders expect to make any money - after delinquencies, defaults, foreclosures, resales...to say nothing of legal and administrative work - on a 0.3% margin? And that's assuming their cost of money is the same as the feds' cost - the long term T-bond rate.

Maybe they should read the paper. John Authers, writing in the Financial Times:

"The latest US mortgage delinquency figures are horrendous, with more than 6% of prime mortgages in arrears - more than double the long-term norm. A quarter of sub-prime loans are delinquent."

And although one in 6 homeowners is underwater...

"The peak of foreclosures has yet to come,' Harvard historian Niall Ferguson adds. 'They will go from 40 percent of all home sales to literally 100 percent by the end of the year.'"

Well, the bankers - as everyone knows - are a lot smarter than we are. They're probably up to the old trick: borrowing short, lending long. The spread between the long rate and the short rate has never been great. We explained why yesterday. The Chinese don't trust Tim Geithner to keep his word. For that matter, neither do we. They've switched from buying long bonds to buying short bills. So, the bankers - including those working for the FHA - can borrow very cheaply in the short-term market. And they can make cheap mortgage loans, long-term. And then, when the short rates go up...and they need to roll over their short- term loans...they can get in line at the courthouse, behind GM and the parts manufacturers...

..and pick out a gaudy casket too.

Bill Bonner
for The Daily Reckoning Australia

• Being a Homeowner is the Beginning of House-Induced-Bankruptcy
• GM Insolvency Can’t be Run-of-the-mill
• The Family Office
• Ireland Going Through Same De-leveraging Process as the US
• Gorgon LNG Deal with China a Really Big Deal

For now, the "bottom" is in - that is, the bottom of this society's ability to process reality. It may continue for a month or so, but events are underway that are beyond the command of personalities. We're done "doing business" in all the ways that we've been used to, but we just can't get with the new program. Let's count the ways:

1. The revolving credit economy is over. It's over because we can't increase energy inputs to the system, which is one way of saying "peak oil." Of course hardly anybody believes this right now because the price of oil crashed nine months ago, along with global manufacturing and trade. But nothing has changed on the peak oil scene - except perhaps that ever more new oil projects have been cancelled for lack of financing, which will boomerang on us (even if swine flu doesn't) in the form of much lower future oil production. In any case, the credit fiesta is over, and the "consumer" economy with it, because industrial growth as we have known it is over. It's over globally, too, though all regions of the world will not experience its demise the same way at the same rate.

The Asian nations may swap things around a while longer but China is basically up the creek without a paddle. They have less oil left than we have (which is saying, not much at all) and they won't corner the rest of the global oil market without starting World War Three. Meanwhile, they're running out of water and food. Good luck becoming the next global hegemon. Oh, and Japan imports 90 percent of its energy; India over 80 percent. Fuggeddabowdit.

Credit will not vanish everywhere overnight - even in the U.S.A. - because it is not distributed equally everywhere. But it will vanish in layers, and here in the U.S.A. a very broad layer of the lower and middle classes are now losing their access to it in one way or another - personally, in small business - and they will never get it back. Anyone who intends to thrive in the years just ahead had better plan on doing it on the basis of accounts receivable - and what they receive might not even necessarily come in the form of U.S. dollars. It may come in the form of gold or silver or in the promise of reciprocal services rendered.

This has enormous implications for two of the items in which our credit-dispensing operations are most deeply vested: houses and cars. Unfortunately, these are exactly the things that economic life has been based on for decades in our nation, which leads to the next categories:

2. The suburban living arrangement is over, along with all its accessories and furnishings. Taken as "all of a piece," the suburban expansion was one sixty-year-long culmination of hypertrophy. We did it because we could. We won a world war and threw a party. We had lots of cheap land and cheap oil. It made lots of people lots of money and all its usufructs have become embedded in our national identity to the dangerous degree that the loss of them will provoke a kind of national psychotic breakdown. In fact, it already has. The completely unrealistic expectation that we can resume this way of life is proof of it.

The immediate problem is that we can't build anymore of it. The next problem will be the failure of the stuff that already exists. The first stage of that is now palpable in the mortgage foreclosure fiasco and, just beginning now, the tanking of malls, strip centers, office parks and other commercial property investments. The latter will accelerate and become visible very quickly as retail tenants bug out and weeds start growing where the Chryslers and Pontiacs once parked. The next stage, which involves large demographic shifts in how we inhabit the landscape, has not quite gotten underway.

3. The Happy Motoring fiesta is over. You'd think that with Chrysler crawling into the bankruptcy court, and GM just weeks away from the same terminal ceremony, the news media would begin to suspect that the foundation of everyday life in this country was cracking. Instead, all we hear is blather about "market share" shifting to Toyota. News flash: not only will we make fewer automobiles in the U.S.A., but Americans will buy far fewer cars made anywhere. We'll keep the current fleet moving a while longer, but when it's too beat to repair, we won't be changing it out for a new fleet - despite all the fantasies about hybrids, plug-and-drive electrics, and so on. The masses will be too broke to buy these things. What's more, they will be very resentful of the shrinking economic "elite" who can afford them. And, anyway, our roads and highways are destined to fall apart very quickly because there is no way we can sustain the necessary rate of normal maintenance. Meanwhile, we remain completely un-serious about public transit - even about fixing the vestiges that still exist. The airline industry, of course, will be toast inside of five years.

4. Our food production system is approaching crisis. There's no way we can continue the petro-agriculture system of farming and the Cheez Doodle and Pepsi Cola diet that it services. The public is absolutely zombified in the face of this problem - perhaps a result of the diet itself. President Obama and Ag Secretary Vilsack have not given a hint that they understand the gravity of the situation. It is probably one of those unfortunate events of history that can only impress a society in the form of a crisis. It also happens to be one of the few problems we face that public policy could affect sharply and broadly - if we underwrote the reactivation of smaller, local farm operations instead of shoveling money to giant "agribusiness" (or Citibank, or Goldman Sachs, or AIG...). I maintain that this may be the year that the crisis gets our attention, because capital is suddenly harder to get than fossil-fuel-based fertilizer.

All these epochal discontinuities present themselves, for the moment, as a season of muted "hope" and general apathy. The days are suddenly mild. We've resumed old and happy habits of grilling meat outdoors and motoring to those remaining places that were not blanketed with franchised food huts and discount malls. We have a new, charming president with an appealing family. Newly-minted dollars are flowing to the "shovel-ready." The new bad news is less bad than the old bad news (or seems to be). And the year just past has been such a bummer that our hard-wired human nature tells us that good things must be just around the corner.

Personally, I think a lot of good things await us, but not the ones we're expecting - not a return to buying Slurpees on credit cards. It will be very salutary to leave behind the junk empire we've accumulated and move into an epoch of quality and purpose. For the moment, though, our hopes reside elsewhere.

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

• The Empty Nest Stage: Henry is Going to the University of Virginia
• Increased Oil Production Won’t Solve the Energy Crisis
• Fannie Mae and Freddie Mac Seized By U.S. Government
• Cash for Clunkers Cars
• A Recovery of Some Kind in Global Trade