- Arthur Rimbaud, "The Drunken Boat"

The news yesterday pushed against us like a gentle wind. Pending house sales were bad. Consumer spending was good. Unemployment was bad. Manufacturing was good.

The Dow rose 47 points. It has moved without much conviction for several weeks. It can't seem to make up its mind. We thought it had headed down decisively a few weeks ago...and then, it stabilized...and wandered about...

Gold has more sense of destiny about it. It's been in a bull market for the last 10 years...and shows no sign of wanting to do anything else. It lost $11 yesterday, but still trades at $1,132...not that far from its all-time high.

Gold is in a real bull market. As near as we can tell it is still in the developing stages. There are a few old gold bugs around. But the public is not yet talking about gold. Investors are not yet adding major positions in gold to their portfolios. Ordinary people are not yet expecting gold to go to $5,000 or $10,000 an ounce.

But the news keeps coming...the opinions...the rants...the data...and the theories...

This way and that...we begin to feel like a "drunken boat." That was the title to a poem written by a 17-year-old Frenchman named Arthur Rimbaud. It describes how we meander. We are driven by the winds...and pushed by the back-eddies... Turning our bow this way ...and then that way...

Never quite sure what direction we're going...or what to think... No one is in control...

And still, the current continues...and we keep heading downstream...carried by the great river...always moving along.

One day we're fascinated by what is going on in Japan. The next day it's China. Some days we think we might somehow muddle through...on others, we're sure something is going to blow up any minute.

But that river just keeps rolling along...and we're on it.

Where does it lead? Well, that's the point. We're not sure...

All we're sure about is that it doesn't lead where most people think. They think they see a 'recovery.' Forget it. Won't happen. We could have another speculative period...but it won't be like the Bubble Epoch of 2005-2007. Houses would have to go up 20% just to get homeowners' heads above the water. Then, maybe they could borrow and spend like it was 2005 again...but that's not going to happen. People don't have the incomes...or the credit...to bid up house prices again.

Here's a headline from The Wall Street Journal: "Employment of Adult Males at Record Low."

Where does that lead? We're not sure...but we don't think it leads to 'growth' in the US economy. Instead, it leads to bankruptcy, deflation...and maybe insurrection.

And what about the Chinese economy? Isn't that growing at breakneck speed - over 10% per year?

The trouble with breakneck speeds is that you do break your neck. China should slow down...or it's going have an accident. And if it slows down, the whole world slows down with it...

And as to that 'growth' - it's counterfeit anyway. It's not real growth...it's ersatz growth, caused by greater and greater government involvement and spending. The feds (the haulers) pretend to be in control. They want us to believe they are in control. But they are out of control themselves!

Can increasing government spending really make people more prosperous?

Show us an example!

Bill Bonner
for The Daily Reckoning Australia

• We are Confident the Bull Market in Gold is Not Over
• Gold is in a Bull Market
• The Final Blow-out Phase of the Gold Bull Market?
• A Bull Market in Gold and Gold Alone
• Gold in the Next Stage of a Bull Market

Consumers spent a little more than was expected of them. And manufacturing did a little better than expected too.

On the other hand, the federal government's tax receipts plunged in the month of February...and bank lending is still contracting. Last week it shrank $33 billion - the 7th week in a row it has contracted.

How does an economy expand when the banks are lending less money? Beats us.

We believe the "expansion" reported in the GDP figures is mostly counterfeit. It's government spending and hot money filtering into the economy. Still, it's amazing that the GDP figures are positive.

The Dow was flat yesterday. The euro rose a little - on expectations of a settlement of the Greek affair. Greece only had a month to sort out its problems. That was two weeks ago. The "clock is ticking," say news reports. Most likely, the Hellenes can't really sort their problems out on their own. Greece will need some sort of bailout - even if it is limited and tentative - from Germany. Stay tuned.

It will be interesting to see what happens when Britain runs into trouble financing its deficits. It won't have the Germans to help. Britain never took up the euro. It will be on its own.

But the big news from yesterday was the $19 boost in gold. Why did gold suddenly shoot up?

We don't know. But our guess is that gold will suddenly shoot up a lot more. We're in a deflationary period. That means everything is going down in price. But against what? Well, against money. Against real money that is - gold.

So gold should continue to go up until this deflationary period is over. That doesn't mean there won't be more hiccups and reverses in the gold bull market. But one of the surest trends of our time is the crack-up of the paper money system. And that is bound be good for gold.

Chris Wood of CSLA says he gives the dollar standard 5 more years. Maybe it will be a bit more...maybe a bit less. But one thing is sure. Governments cannot continue to run such huge deficits forever. There will come a day of reckoning...

The feds are hoping it comes at a time and place of their own choosing. They all want to ease their way out of their troubles...with the help of consumer price inflation. You heard central bankers talking last week about increasing the inflation target from 2% to 4%. If they can actually control inflation so precisely, it will be a miracle. But that is what they hope to do.

A few years of 4% inflation would do wonders. In ten years, they would have cut a third of the national debt - in real terms, of course (supposing that they don't add to it even faster). Not only that, the debts of the private sector would be eased too. At 6%...debts would be cut in half in a decade. With half the debt burden - the private sector might be ready to begin a new period of growth. That is the feds' real strategy...to de-leverage the private sector enough that it can grow...and increase tax receipts.

By the way, that was what happened in the Reagan administration. The inflation of the '70s forced up interest rates and caused the worst recession since the Great Depression. But it also lightened debt loads - so much that the economy was ready for another big growth spurt.

This growth really paid off in the '90s...and the very early years of the Bush junior administration. Thanks to growing tax revenues, both Clinton and Bush were able to pay down the huge debts of the Reagan years...and still increase spending. The economy was able to "grow its way" out of debt.

Then, with the war on terror and the micro-recession of 2001, the budget magic of the '90s was lost. Bush apparently never met a spending bill that he didn't like. Spending exploded...especially time bomb spending for health care, which increases automatically year after year.

Then came the depression...known popularly as the Great Recession of 2007-2009. Tax revenues fell. Spending increased even more. And now the deficits come hard and fast. And there seems to be no way to "grow our way out" of them. All of the conditions that made for a boom in the early '80s are making for a bust in the early 2010s. Interest rates are at record lows, not record highs. Stocks are high, not low. Bonds are high, not low. The government is the solution, not the problem.

Bill Bonner
for The Daily Reckoning Australia

• Have the Feds Given the Economy a Miracle Drug?
• Japan and its Economy Did Not Have Secret to Everlasting Success
• The Fallacy of the Fallacy of Composition
• Government Pretending Debt-fueled Spending is the Same as Growth
• China Reduces Holdings of Treasury Securities

Ah ha! We'll explain in a minute.

First, the latest from Wall Street: The Dow fell 18 points yesterday. We're still not sure whether the final, fading phase of the bear market has begun or not. This bounce took the Dow back to 10,725 on January 19th. It hasn't seen that level since. Was that it? Was that as high as it's going to get? Is it down from here on out... until the Dow finally bottoms out somewhere south of 5,000?

We don't know. We'll just have to wait to find out... along with everyone else.

Now... back to that 'recovery'...

It's true that there are some signs of "stabilization." The unemployment rate is not getting badder as fast as it was a few months ago. And house prices seem to have stopped falling - for the moment.

It's also true that the economy managed to register positive 'growth' in the last quarter... mostly thanks to government spending and inventory restocking.

The trouble is, all of these things are consistent with a depression - especially a depression that the feds are fighting every inch of the way. In the 1930s, there were several years of growth... and there were great years for the stock market too. Then, things fell apart again. The nation ended the '30s not one penny richer than it had been when it began them.

And Japan has seen some good years and some bad years, too, since its depression began in 1990. Oddly, Japan's population is falling... so in per capita terms, Japan's downturn hasn't really been so bad. Per person, the Japanese got richer over the last 10 years.

It's also true that here at The Daily Reckoning, we use the term 'depression' a bit differently than most economists. Most economists believe GDP growth represents increasing prosperity. They think a depression is merely a recession, with negative GDP growth, that lasts longer and goes more deeply than normal.

Our definitions are better:

A recession is a pause during a period of growth. A depression marks the end of the period of growth... giving the economy a chance to make adjustments so that a new period of growth may begin.

GDP growth alone is a fraud. The gross number just doesn't tell you anything worth knowing. It doesn't really matter how fast an economy is growing. What counts is how fast it is growing per person... and whether that 'growth' is real or phony.

Growth is not the same as prosperity...

Someday, we promise you, modern economists will be ranked below doctors who bled their patients to death and jungle tribes who threw maidens into volcanoes. They are quacks.

These imposter economists think they can fix a recession and prevent a depression. When the private sector stops spending they urge the public sector to step in and replace the missing private spending. That, in a nutshell, is Keynes' theory.

A nutshell is the appropriate container. Because there's a world of difference between private spending and government spending. Private spending is voluntary; people choose to spend their money on things they really want. When the government spends, on the other hand, it is merely squandering stolen property. It may look like private spending. But it's not at all the same thing. You can hand out checks to people; it's not the same as when people earn money. You can build bridges and airports too... but they are only valuable to the extent that they are used efficiently. And you can hire all the government employees you want; they don't necessarily add to the sum of human happiness or wealth (most likely they subtract from it!).

Just look at societies that put everyone to work. There was no unemployment in Cambodia under the Khmer Rouge! Or in the Soviet Union. North Korea is another good example today. They all show that putting people to work for the government doesn't make them rich... it makes them poor.

Yet, these modern economists - Martin Wolf at The Financial Times, Paul Krugman at The New York Times, Bernanke, Summers and Geithner in Washington - believe that they can control and cure a depression. All they have to do is to keep the GDP expanding... and keep unemployment from rising. How? Just spend money!

The GDP calculators can't tell a phony expense from a real one. Whether the government spends money to do something that is not worth doing... or hire someone who is not worth hiring... or just gives away money to someone who is not worth giving money to... the GDP quants don't know the difference. They think one dollar spent is as good as any other...

... even if it is a dollar that didn't exist! (Don't get us started on that one... )

And who knows if a job is worth doing? Only the person who pays for it. That's the trouble with government employment; the people who pay the bills don't make the hiring decisions.

Modern economists don't even bother to think about it. All they care about is the unemployment rate... not about whether the job is actually useful or efficient. Want to boost the job rate? Easy. Just hire people. Does this make people better off? Of course not.

The Financial Times had a full page in its Wednesday edition devoted to China's empty towns. Bloomberg has been on the story too.

It is the story of what actually happens when government meddles in an economy.

Last year, China ordered its banks to lend money to infrastructure programs in order to offset the worldwide financial meltdown. The banks responded, doubling their lending.

Observers in the West were stunned... and envious. If only we could 'get things done' like that, they lamented. If only our governments had more authority and control over the economy!

But let us go back a year and put ourselves in the shoes of the bankers. They must have had loan requests. Some of them they must have judged worthy of funding, others not. But how was it possible that the number of project deemed creditworthy doubled in the space of a few months?

Well, it didn't happen. Instead, the Chinese government merely changed the rules of the game. The banks, under pressure to loan out money, reacted by lending it out... to marginal projects. Now, we're beginning to read about them in the paper - mostly towns without any people. Just wait until China blows up. Then, we'll read about banks without money. Stores without customers. And businesses without a prayer.

China is either going to blow up... or slow down.

Bill Bonner
for The Daily Reckoning Australia

• Ben Bernanke Averts a Second Great Depression
• Depression: A Time of Falling Prices
• How Does an Economy Expand When the Banks are Lending Less Money?
• Stocks, Bonds and Economy All Bounce
• Feds Think They Have Won This Fight Against the Depression

The good news is that housing prices are going down. That's what The Wall Street Journal says. "Home prices declined in November." Good. People will be able to find more affordable housing.

Wait. That's not good news, is it? Doesn't that mean we're still in a depression? Besides, another report says housing is going up. What to believe?

Let's try something else... Consumer confidence rose in the latest reporting period. No argument there...

Now, that's definitely good news, right? Nope. The better things get the more likely the feds are to clamp down on the recovery by "exiting" their stimulus efforts and reducing the deficit. That's part of the reason stocks often decline when the news is "good" and go up when it is "bad." Investors are afraid the feds will take away the juice. That would risk a return of the "error of '37,"...say economists such as Paul Krugman and Richard Koo. Ignoring the calendar a bit...it would turn our president into "Herbert Hoover" Obama, as one commentator suggested.

What happened in the '30s? Well, in the approved storyline, the feds had their stimulus foot to the floorboards...and they were happily driving right out of the depression. But fearing inflation...deficits...and a backlash against excessive spending (and believing that they were clear of the bad neighborhood) - they slowed down...they eased off their stimulus efforts in the mid-'30s. This sent the economy into another downturn and stretched the depression out for another 3 years.

It's nonsense. What really caused the relapse of '37 was the feds' own meddling. But that's not the way mainstream economists and analysts look at it. In their cockamamie view, an economy grows thanks to the good stewardship of publicly elected officials. In their view, government spending is actually BETTER than private spending. Why? Because it produces nothing of value. Really; we're not making this up. And so what if the government doesn't have any money? To them, money that doesn't exist - created 'out of thin air,' as Keynes put it - is BETTER than real money. Because it creates consumer price inflation. Up is down. Good is bad. Better is worse. In their view, what makes a strong economy is government action. Specifically, government spending. So, anything that might incline the feds to spend less is BAD news.

According to the papers, there's some bad news coming. 'Cause Mr. President is going to tell the nation in his State of the Union address that it's time to put on the brakes. If we don't, people will get the impression that government spending is out of control. We can't have that. Because lenders might refuse to lend. Investors might refuse to invest. Voters might refuse to vote for the scalawags now in office.

On the other hand, if the Prez really does cut spending, none of the aforementioned are likely to be very happy about it. Federal spending doesn't really make people richer; it makes them poorer. Still, appearances are what really matter. Dim economists want a president who puts into action their loopy theories. And dim voters want a president who takes action to save them from their own mistakes...especially when it means getting their hands on someone else's money.

The stimulus offered by government spending is phony. But it appears real to the masses. Take it away and the economic consequences will appear very real too. The 'creative destruction' of the market will finally get to express itself. Businesses that should fail will fail. Speculators who ought to lose money will lose money. There will be blood, in other words.

Like most people, we don't mind a little blood...as long as it's not our own. So you can imagine how the parasites will howl when they see the knife draw near to their own arteries!

They can relax. The feds are not likely to reduce spending significantly. The deficits are structural...they're built-in to the system...they won't go away.

And as the depression lingers, the debt piles up...

What will happen? We don't know. We can't look into the future. But we can look at Japan...a country that is at least 10 years ahead of us.

Why is Japan ten years ahead? Because its stock market turned down in 1989...a decade ahead of Wall Street. And because its population is about 10 years older. And because it's been fighting the de-leveraging process for 20 years. What can we learn? Here's the latest from the WSJ, warning of an explosion:

"S&P lowers Japan's outlook to negative."

Uh oh. Not too encouraging. The rating agency told Japan that if it didn't cut its deficits its debts would be downgraded.

Ah yes... Thanks to the Japanese, we get to see someone cross the minefield ahead of us. After 20 years, Japan hasn't been able to get clear. But it hasn't blown up completely, either.

But watch closely. It's putting its feet down on some dangerous ground. Deficits have grown and grown and grown. Now, it risks an explosion with every step. This year, it will borrow $480 billion. It will receive only $405 billion in tax revenue. As far as we know, no major economy has ever run so far into the red without a blow-up.

And what can it do? They are getting the same sort of advice as Obama. They're told they must cut the deficit to protect the currency...the economy...and the credit rating. But they're also told that good is bad, or bad is good...that if they do the right thing - cutting the deficit - the economy will suffer. Tax revenues will fall further...widening the deficit!

The Japanese economy has become so dependent on debt-fueled government spending that, take it away and things fall apart. In the long run, that is exactly what should happen. The economy needs a shake-up...so it can rebuild on more solid foundations. But what politician wants to risk his own blood?

Bill Bonner
for The Daily Reckoning Australia

• Only Thing Rising Faster than Demand for Government Debt is Supply of It
• U.S. Government Spending $13 trillion to ‘Fix’ Problems
• Take Away Stimulus Spending and You’ve Got an Economy Entering Depression
• Obama and the $3.8 Trillion Budget
• Japan and its Economy Did Not Have Secret to Everlasting Success

But don't worry about it. Now, we're not threatened by inflation...but by depression!

It's fighting the depression that makes people worry. Smart investors and shrewd central bankers are afraid the depression-fighters will go too far...that they don't really know what they're doing.

Ben Bernanke is up for re-appointment. "Bernanke fights for 2nd term," says The Wall Street Journal. Does he know what he is doing? Well, no. He was wrong about the biggest single event in recent financial history. He thought the 2004-2007 super bubble was actually a period of "great moderation" brought about by his own superior monetary policies! He was still patting himself on the back when it blew up in his face.

And now, he still thinks the way to solve a problem caused by too much debt is to offer more debt. Of course, it didn't work for the Japanese. It won't work for us. But what we don't know is HOW it won't work.

That is big question. Will the feds simply retard a real recovery...with their bailouts and boondoggles...causing a long, slow motion depression, a la Japan? (In this case, gold may not be the one- way bet the smart money thinks.) Or will they tip the world into a hyperinflationary catastrophe, like the Weimar Republic in the '20s or Argentina in the '80s?

We don't know. No one knows. We wait to find out...

Bill Bonner
for The Daily Reckoning Australia

• Volcker, the Last Central Banker in America to Have Any Real Integrity
• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
• Two Ways to Deleverage an Economy
• Does Gold Do Anything But Rise?
• Depression: A Time of Falling Prices

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Gold, meanwhile, held above $1,100.

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

What are we thinking about?

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

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

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

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

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

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

Answer: no.

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

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

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

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

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

Trouble is, they can't.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Government Debt
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• US Economy Still in a Deflationary Contraction
• If the Economy is Recovering Maybe the Feds Will Reduce their Stimulus
• Government Spending Makes People Poorer

Of course it was misery for many of the test subjects. People were so eager to get out of the East German control group, they risked their lives jumping over the barbed wire. Then, when the wall was down, the population of East Germany collapsed...more than one out of every ten people moved to the West!

But it was a great experiment for economists. Too bad they didn't learn anything.

What they should have learned is that when it comes to making people materially better off, government spending is a poor way to do it. It's great for the few favored firms who help Washington raise and spend its trillions. It's great for Goldman, in other words.

But what if you don't have an inside track with the government? Well, you're out of luck. You get to stand in line to buy inferior goods and services - produced by government-owned industries and protected monopolies. That was what the East Germans did. And, of course, you get government bureaucrats telling you what to do...and preventing you from improving the quality of your life.

That's what they did in East Germany. And that's what they're doing, now, in the United States of America - in a less obvious, less heavy- handed fashion. Who owns the biggest auto company in the US? Who provides the finance for the finance industry? Who controls the health care and education industries? Who's the biggest employer? Who finances our houses? Who runs our banks?

Well...you know the answer.

But here's another question: who's headed for bankruptcy? Same answer.

What can you do about it? All you can do is to anticipate where this is heading...and position yourself to profit. Or, at least position yourself to protect your assets.

In that regard, you may want to replace the FED with the GLD, if you know what we mean. The Fed is derelict in its duty to protect your paper dollars. GLD - an ETF for gold - is a very simple way of doing your own central banking.

But should you buy GLD now? Ah...they don't make it easy, do they?

So, should you buy gold now?

A quick answer: it depends.

If you're buying gold for quick profits, you will probably be disappointed if you buy it now. The price has been going up for weeks. It's probably ready for a rest.

Also, gold moves up with stock prices - both anticipating an inflationary recovery. We think this will turn out to be a mistake. There is no real recovery underway. And no inflation either.

If and when stocks collapse, gold will go down too. At least for a while.

But if you are buying gold as the Chinese and the Indians are buying it - as a monetary reserve, not a speculation - there is no time like the present. Sometime in the future, we wish we could tell you when, gold at $1,100 will seem like a giveaway.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Gorbachev and the Most Complete Test in Economic History
• Gold is in a Bull Market
• The Codependent Relationship Between China and the United States
• U.S. Government Takes Over the Economy
• Housing and Unemployment Are Weaknesses in the U.S. Economy

The quote comes from Ben Franklin. But it was recalled to us neither by America's president, nor Britain's Prime Minister. Instead, the Telegraph in London reported it from the mouth of Cheng Siwei, a "top member of the Communist hierarchy."

What goes around comes around. The Anglo-Saxons have forgotten what makes a successful economy. The Chinese have remembered.

Just look up Warren Harding on Wikipedia. The first entry you will find is not the 29th president of the United States of America, but a rock climber with the same name. But what do you expect? History is nothing but a long list of disasters in chronological order. Historians love calamity. And they reserve their highest accolades for those who cause them. The same is true in financial history. Those who make it big are those who make it worse.

It is safe to assume that no one working at the Federal Reserve or at the White House has a picture of Warren Gamaliel Harding over his desk. Yet, if American presidents were ranked on the basis of how well they faced up to financial disaster, Warren G. Harding might be somebody. His handsome face would be carved on Rushmore. His likeness would grace the $100 bill. Harding was the last American president to deal honestly with a major financial crisis. Every president since has tried to scam his way out of it.

By the time Harding took office in '21 the Panic of 1920 was taking the unemployment rate from 4% to nearly 12%. GDP fell 17%. Then, as now, the president's subordinates urged him to intervene. Secretary of Commerce Herbert Hoover wanted to meddle - as he would 10 years later. But Harding resisted. No bailouts. No stimulus. No monetary policy. No fiscal policy. Harding had a better approach; he cut government spending and went out to play poker:

"We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity...it will be an example to stimulate thrift and economy in private life.

"Let us call...for a nationwide drive against extravagance and luxury, to a recommittal to simplicity of living, to that prudent and normal plan of life which is the health of the republic."

Within a decade, Harding's views were collectibles. But in 1921, he still saw the economic world as a moral world ordered not by man, but by God. This was not the result of long study or deep reflection on his part. He was probably the dummy everybody said he was. As Keynes pointed out, politicians are always in thrall of some dead economist. At least Harding was in thrall to the good ones.

"No statute enacted by man can repeal the inexorable laws of nature," he announced. "Our most dangerous tendency is to expect too much of government..."

Harding was not the first to see the economy as a 'natural' order...one that you disturbed at your peril. A Taoist named Zhuangzi, who lived about the same time as Alexander, observed: "Good order results spontaneously when things are let alone."

Later, economists of the Scottish enlightenment, notably Adam Smith and Adam Ferguson elaborated. Smith, like Harding, saw the economy ordered by the invisible hand of God. Ferguson saw markets as a 'spontaneous order,' which were the "result of human action, but not the execution of any human design".

The same basic insight led Irving Fisher - the greatest economist of the 1920s - to come up with his debt-deflation theory of depressions. After people had borrowed, they needed to pay back. Busts followed booms; there was no getting around it.

Warren Harding may never have been the brightest bulb on the White House porch, but intuitively he understood that proper macro-economic policies were more the product of virtue than of genius. Debt led to trouble; that's all he needed to know.

Keynes came along a few years later. Keynes was a genius; everybody said so. And he had an answer for everything. Nature? Government could do better. Debt? Don't worry about it, he said. Why not just let capitalism sort itself out? Without government intervention, it will only get worse, said Keynes.

But Harding had already proved him wrong. Harding did the very opposite of what Keynes recommended. Instead of increasing government spending, he reduced it. He cut the budget almost in half. He slashed taxes too...and cut the national debt by a third.

Japan at the time struggled with the same downturn. But it had no Harding at the helm. Instead, its masters prefigured Keynes, trying to stay the correction using price controls and other interventions. The result was a long-drawn-out affair that lasted until 1927 and ended in a bank crisis. In America, meanwhile, by 1922 unemployment was back down to 6.7%. By 1923 it was down further - to 2.4%.

This lesson was entirely lost on the world's economists. When the next crisis hit a decade later, they turned to Keynes. Of course, it turned out to be a moral world after all. They got what they deserved.

Regards,

Bill Bonner,
for The Daily Reckoning Australia

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"Chinese economy bounces back," says one headline in the International Herald Tribune.

"JPMorgan profit soars despite downturn," says another.

The average reader or TV viewer will go no further. "Ah," he says to himself, "good news; the worst is over. China is a green shoot as big as the Amazon. And JPMorgan is a leader in the financial sector. If the financial sector is doing well, the whole world economy must be doing well."

But here at The Daily Reckoning, we can't help ourselves. If we see a silver lining, we look for the cloud. We see garbage...we look for the rat... We begin with the JPMorgan profit announcement, because it is the most intriguing. Let us set the stage:

In the last half century, credit has expanded faster even than dress sizes. Naturally, this has made the business of hawking credit extremely profitable. Profits in the financial sector soared to 40% of the U.S. total. And every momma wanted her baby to grow up to be an investment banker.

But then, in 2007 & 2008, the bubble in the financial sector popped. Many banks and financial institutions went broke...or had to be bailed out by the government. Instead of being the world's highest-flying industry...finance became the scene of its biggest crash.

And now, from all we've been able to detect, a fundamental shift has occurred. People are no longer eager to go deeper and deeper into debt. Instead, they are eager to pay off debt...that is, to rid themselves of finance...and to get as far away from the financial sector as possible. Savings rates, for example, have gone from zero to 7% in just the last 12 months.

But in the midst of this remarkable and historic change, we get news that at least a couple of the biggest firms in the financial sector - JPMorgan and Goldman Sachs - are making billions in profits:

"Even as it weathers the worst economic downturn in decades, JPMorgan Chase said Thursday that it had made a $2.7 billion second-quarter profit as a result of stellar trading and investment banking results."

This was essentially the same story we got from Goldman. Neither bank made its money the old fashioned way -- by lending to worthy projects; they made their dough by "trading" and "investment banking." In other words, they made billions from speculation.

Anyone who takes this as evidence of a recovering economy should work for the government. Only a government economist or a mental defective (excuse us for being redundant) could believe that genuine prosperity can be built on a foundation of speculating by large financial institutions. You can see why by asking a simple question: whom were they trading against?

Speculating is a zero-sum game. No matter who wins, the economy is not a bit better off; it has not a centime more in resources. Goldman and JPMorgan report earning, together, more than $6 billion. Who was on the other side of that trade?

There is also something fishy about the whole thing. Trading is not only a zero-sum game, it's a game of chance. Traders lose money about as often as they make it. Of course, normally, the traders at the big banks have an advantage; they are not idiots. They make money by taking it away from the amateur traders, who are idiots. But what amateur traders put up $6 billion?

Our guess: the fix is in. They are taking advantage of the feds' stimulus programs...and trading against the biggest patsy in the world, the U.S. taxpayer. How? We'll find out how, later...

Meanwhile, there is the news that China is back in business.

"Government spending pushes GDP growth to 7.9% for 2nd quarter," reports the IHT, "...fueled by a large economic stimulus package and aggressive bank lending...a surprisingly strong showing during the global economic downturn...

"...while most other major economies are contracting and suffering from the worst economic crisis in decades, China appears to have turned a corner...

"Growth in the second quarter was driven by strong auto and property sales, a rebound in manufacturing and huge infrastructure spending, which was propping up global commodity prices."

Further investigation reveals that bank lending and property speculation have gone wild. (More on this in today's essay, below...) And stocks in Shanghai are up 75% so far this year.

Now, let's try to get this straight. The world is in a slump. China sells stuff to the world. And yet, China is booming.

How could it be? Again, there's something fishy about it...as if the government were jiving the figures...as if the speculators had taken leave of their senses...and as if the whole thing were just the result of the same kind of misguided 'stimulus' that got us into trouble in the first place...

The Richebacher Letter's Rob Parenteau agrees that something isn't quite right. "Ask anyone who's done business there. Keeping a double set of books in China isn't just common, it's considered 'good strategy.' You've also got under-regulated Chinese banks hiding as much as $500 billion in bad debts - China's own version of 'subprime' loans to small businesses and Asian property speculators.

"On top of that, you've got a $40 billion tab left over from the Beijing Olympics... and a $140 billion tab for rebuilding Sichuan after their 2008 earthquake."

Boom...boom...ka-booooom!

Regards,

Bill Bonner
for The Daily Reckoning Australia

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"A surprisingly bleak forecast for the world economy pushed stocks to their biggest loss in two months."

That's not something we've said, that's straight from the Associated Press. It's based on research released by the World Bank.

Considering the fairly poor record of any government endorsed institution to predict the current economic downturn, we're almost tempted to think we should view this as a reason to become bullish on the global economy.

But we won't just yet.

If you fancy reading the full report from the World Bank, you can do so by clicking here. It's 167 pages of pure delight.

The World Bank is clearly in a difficult position. It needs to lay on the sauce to highlight how bad things are - so it can get increased funding - yet compliment its paymasters (governments) on the:

"[A]mbitious unilateral and multilateral actions, both conventional and unconventional, governments have drawn on monetary policy, fiscal stimulus, and guarantee programs to shore up the banking industry, which lay at the epicenter of the crisis."

All of which "are beginning to have a positive impact on financial markets."

They are certainly having an impact. Whether it is positive is another matter.

In fact, based on the story on the front page of today's Australian Financial Review (AFR), the seeds for a further slump appear to have not only been sowed, but are being nicely watered in as well.

The AFR tells us:

"Business stocks up on stimulus-package tax breaks."

The story goes on to say, "Businesses are pulling forward capital expenditure to take advantage of the Rudd government's $3.7 billion tax break for investment in new plant, equipment and motor vehicles before the end of the financial year."

Conventional wisdom, ie, the wisdom of the mainstream press, is that this is good. They'll tell us it's a good sign for the economy. They'll tell us that business is seeing the 'green shoots' of recovery. Just like they have done about rising bond yields - more on that below.

They'll also tell us this will be good when the consumer is ready to spend again next year.

We don't have a problem with predictions. We're prone to make the odd one or two as well. But we do have a problem when the entire basis of the prediction stems entirely from arbitrary and non market-driven government aid.

Let's look at the facts. Why are these businesses bringing forward capital expenditure? They are doing so for one reason only - for a tax break. There is little difference between a business and an individual making an investment purely due to a tax break.

They are both destined to end in tears, unless there is a genuine economic or financial reason for the investment. As you know, we're not a fan of taxation. But we also know that governments have no intention of lowering the tax burden. Any tax cut today, is a tax increase tomorrow.

The AFR points out Caltex is bringing forward "$9 million of pump supply and installation at its service stations." For what reason? "before July 1, when the 30 per cent investment allowance for large businesses winds back to 10 per cent."

But as Money Morning reader Andy asked yesterday on the subject of government spending, "isn't this consistent with one of the aims of government - to smooth out the cycles - by creating jobs in a recession, and restricting job growth in a boom?"

The simple answer to that is, that's what governments will tell you they do. Hence the clamour to get all the stimulus packages approved, so that government could "fill the gap" left by the private sector, and to be seen to be doing something.

What they forget to add is that it's the policies of government and central bankers that cause the problems in the first place - I guess you could argue it's only right they try and fix it! Except they just end up making it worse.

As we've stated before, government incentives and tax breaks only succeed in misallocating resources at precisely the wrong time. Currently the economy is trying to shrink. It has experienced a boom and therefore it must shrink.

Any attempts to stand in the way of this merely prolong the effects of the downturn and makes it worse.

If we use the example of Caltex above, we can assume they already had plans to invest in "pump supply and installation" at its service stations. Based on its revenues and profitability and budgeting we'll assume it had previously planned to do this sometime later than July 1st.

Perhaps much later.

However, the incentive of a government subsidy has caused Caltex to bring that expenditure forward. Possibly forward to a time when they hadn't considered it to be economic.

The government incentive changes that. We can assume therefore that Caltex is taking on extra risk by doing so. Instead of basing its decision on profitability, it is basing the decision on getting a tax break.

If we amplify this same example across the entire economy, there will be thousands of businesses contemplating exactly the same thing. They will splurge on capital goods now, just because the market is being distorted with the tax break.

Of course no-one's forcing them to do it. But that's where the fear of losing out comes in. If Business A doesn't invest now, he'll fear that his competitor - Business B - will do so, and potentially gain at Business A's expense if the economy does pick up.

Normally a business would make the judgment to invest based on expected profitability of the investment - sometimes they get it right and sometimes they get it wrong.

The real danger now is that money is being borrowed and profits spent in the hope that the increased capital expenditure will pay off next year as demand rises from business and consumer customers.

The only problem is that if all the spending is taking place now, who will be left to spend next year? Especially as the costs of these expenditures have to be built into the product price.

What happens if spending doesn't pick up? Because businesses have brought forward all their investment to today. Don't forget, there are still forecasts for unemployment in Australia to rise above 7.5% - some have even forecast closer to 10%. Companies are laying off staff, and corporate and government borrowing must still be repaid.

And it doesn't help matters when bond yields continue to rise, as you can see from an update to the Aussie Bond Yield Curve we've been publishing recently...

Interests rates are moving higher and therefore the cost to business and consumers is moving higher. That's when the impact of inflation really starts to bite.

So, far from government stepping in to smooth out the business cycle, it actually steps in to contribute to the booms and busts and damage the economy further.

Based on the reaction of the markets in recent weeks, the rose-tinted glasses worn by those who believed in a strong economy next year are starting to become a little more tarnished.

Kris Sayce
for The Daily Reckoning Australia

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