They were valuable because they helped frame where we are in the mortgage crisis, which has been the main shark in the water over the past couple of years. You should know where that shark is and whether or not it is hungry. The chart below shows you the ferocious fish may still have an appetite.

It shows you that we are past the viscous subprime crisis, when that shark chewed through the balance sheets of a number of banks and financial institutions, in some cases devouring them whole. However, it is not yet safe to get back in the water:

There are these other slices of mortgages that are not quite as risky as subprime that reset in the next couple of years. Years 2010 and 2011 face big resets in so-called Alt-A and Option ARM loans. What this means is more write-downs and more losses for banks and others who hold these mortgages.

Making all this worse is the fact that the housing has not yet recovered. The T2 duo made the case that the current "stabilization" of the housing market is a head fake. Mostly, it's due to huge government support of the housing market. But there is still a large inventory of homes out there. And with these resets coming due, we've still got a large amount of foreclosures on the horizon.

All the while, the unemployment numbers are still poor. The T2 duo calls the unemployment situation the "most severe since the Great Depression." The US economy has shed over 8 million jobs in this recession and unemployment - officially - is nearly 10%.

Plus, it's not like the average US consumer is in a good position to sail through this crisis. Household liabilities are still high, as this next chart shows:

US consumers need to save and rebuild their financial strength. This is why the savings rate is on the rise. This is why, for the first time since the 1950s, household credit debt declined.

As investors, it seems clear that any idea that depends on discretionary consumer spending - say, buying trendy new sweaters or watches or expensive shoes - faces some big head winds. Better to the stick with the necessities, I say.

Also, it looks like the bounce in the stock prices of overleveraged banks and financial institutions is premature. Most bank stocks should be sold, not bought. The bounce in home building stocks looks ridiculous in light of what they have to look forward to. The T2 duo actually recommended shorting the home building stocks through the iShares Dow Jones US Home Construction ETF (ITB). By shorting it, you make money when the stock prices of the home builders go down.

They made a compelling case, of which I will highlight a few things. Exhibit A would be the fact that the average new home has been on the market for 12.9 months. Exhibit B is that we have about 2-3 years of existing home sales just to absorb the vacancies that exist. According to T2, about 6% of all homes built this decade are vacant.

Exhibit C is that the home builders themselves have too much debt and too much inventory relative to their thin equity cushions. The home builders are in the position of trying to hold up a bowling ball with a sheet of paper...in the rain.

Lastly, the home builder stocks are almost universally expensive on a price-to-book basis, as this chart shows:

Stocks with lots of debt, too much inventory and an awful market don't deserve premiums over book value. Discounts are more like it.

So there you go. I like the idea of shorting the home builders. At the very least, I wouldn't buy one. I'd also stay away from banks and financial institutions that hold mortgage assets. American real estate is not worth zero, as Dobson said, but it can be worth a lot less than today's price.

I recommend staying with the sorts of companies that own essential assets and/or sell essential items. As I like to say, stick with what keeps civilization a going concern. And avoid any stock that is dependent on regular access to the credit markets. As we saw in 2008, a mortgage crisis can shut down the credit markets. We don't want to be held hostage by lenders in that situation, so stick with excellent financial conditions.

Regards,

Chris Mayer
for The Daily Reckoning Australia

• All Ordinaries Reach 52 Week Low
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• The Two Pillars of the U.S. Mortgage Market, Fannie Mae and Freddie Mac, Wobbled Again Yesterday

The stock market rallied throughout most of yesterday's trading session, then stumbled into the close. This pattern has become unnervingly familiar of late. It's true that the Dow has only dipped 2% since closing a notch above 10,000 on October 19, but the decline feels a bit worse than that. Maybe that's because so many midday rallies have turned into late-day selloffs.

Or maybe the market feels so weak because it IS so weak. Most of the broad indices like the S&P 500 and the NASDAQ Composite are down more than 5% from their recent highs. Meanwhile, former market leaders like the BKX Index of financial stocks have tumbled more than 10% from their recent highs. These corrections aren't devastating, just discomforting.

Every rational investor knows that the market recovered much more ground from its March lows than economic fundamentals warranted. But that doesn't automatically mean that the market is a "sell." Maybe it is just a "do nothing for a while." Your editors are agnostic on this topic. But almost no one else seems to be. When the stock market becomes as volatile as it has been lately, every stock market commentator from Pensacola to Pismo Beach trots out a forecast - usually based upon stock charts that show trendlines, resistance levels, Fibonacci retracement points, stochastic indicators etc.

Unfortunately, the identical price charts can yield completely opposite forecasts. Show us a trendline, and we'll show you two emphatic forecasts - one bullish, one bearish. Both forecasts will be honest and informed by experience, but only one of them will be correct.

That said, our friends over at "Penny Trends" delivered a very persuasive (and bearish) forecast yesterday, based on a very clever technical indicator:

"The market is rolling over... The transformation is amazing... Our list of exchange-traded funds (ETFs) is one of the best tools we've ever developed for determining the trends in the markets. By distilling the investment universe into just 87 'baskets' of stocks, and then ranking them by three-month performance, we get a fantastic sense of the big picture. We can tell immediately if investors are building optimism or sinking into pessimism. And we can see which individual sectors and markets are strong and which are weak by the way they react relative to one another. For example...

"A month ago, the five best-performing ETFs in the world were showing an average three-month gain of 34%, while the five worst-performing ETFs in the world were showing an average loss of just 8%. Now, the five best-performing ETFs are up an average of just 17%. The bottom five are down an average 15%. In other words, uptrends are getting weaker and downtrends are getting stronger. It means the market is probably rolling over.

"Here's another way of looking at the same thing: The 87 ETFs we monitor represent every major currency, stock market, sector, and commodity. A month ago, only eight of the ETFs on our list were showing a three-month loss. That means 79 were showing a three-month gain. Now, 22 ETFs are in negative territory and only 55 are in positive territory...another strong sign the market is rolling over."

But don't let this forecast bring you down, dear investor. Things could be worse. The stock market could be just as bad as the housing market.

"But wait just a minute!" some readers may protest. "Isn't the housing market recovering?"

Well, sort of. Prices are no longer in freefall. But a sustainable recovery still seems like a delusional hope...especially when one considers that there's a lot more pain to come in the mortgage market.

Eric Fry
for The Daily Reckoning Australia

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Not much happened yesterday. The Dow fell 47 points. The newspapers attributed the reversal to surprisingly low consumer confidence numbers. Apparently, consumers aren't so sure this crisis is over. As we reported yesterday, they're saving money...maybe even at an 8% rate.

Oil didn't move yesterday. Neither did gold.

The Wall Street Journal reported that markets were reacting to "mixed data."

That is to say, some reports were encouraging. Others were not. It was as if one weather forecaster called for a blizzard and the other for sunny skies and warm temperatures. Investors didn't know how to dress.

Among the dark clouds was an item on the falloff in tax revenues. States are having a hard time balancing their books, because their tax receipts are declining. The WSJ reports that they are running 17% below last year. Since states cannot print money, they're forced to make cutbacks - typically reducing hours worked per employee as well as the total number of employees. This is a bad thing, says the report, because it increases unemployment and lowers the wage base, leading to less consumer spending.

Another little cloud appeared yesterday (in addition to the consumer confidence numbers): the vacation timeshare market is collapsing at a record pace.

Well, don't worry about it. We met a guy who explained the timeshare business to us.

"What you're selling is a dream. You bring them to the property. You make sure they have a good time. And then you do to the numbers with them. You show them how much they save by coming to your property rather than on a typical vacation. And then you show them the other properties that they can exchange for. They think they can buy a cheap property and then exchange with an expensive timeshare. But it doesn't work that way. They get stuck in the cheap unit and the dream gets a little faded. And then, they stop coming...and then they try to sell the timeshare. Timeshares are rarely a good investment."

Besides, timeshares are a small, quirky part of the housing picture anyway. The real story is in the regular housing market. There, if you believe the forecasters, it's sunny skies.

House prices seem to be stabilizing. In some areas, they are going up. Of course, in some places you can get a house at half the price it sold for two years ago. That lures buyers back into the market. If we wanted a house to live in, we might be tempted too. That's why we like falling prices in housing; we get more for our money. But most people want a rising housing market. They think it makes them richer.

They're likely to be disappointed. They show up at the beach with their umbrellas and sun tan lotion...just as a winter storm hits the coast.

Forbes lists eight reasons to "remain worried about housing":

• The federal tax credit, worth $8,000, is set to expire at the end of November. That will make housing $8,000 more expensive for first-time buyers.
• The Fed is also ending its $1.45 trillion shopping spree. It has been supporting housing by buying mortgage-backed derivatives. What will happen when it stops?
• Mortgage lending standards are tightening up generally.
• Houses are still not cheap. Forbes cites Shiller's numbers, putting the average house 41% higher than it was in 2000. Incomes did not increase during that period; ergo, houses are still too expensive.
• Damaged psychology. It will take time for potential homeowners to get over the shock of a bear market.
• The end of summer has arrived. Housing sales always go up in the summer. People relocate in summer, when school is out. Then, sales fall with the autumn leaves.
• There are still huge numbers of houses that will be foreclosed. Forbes says only 12% of option ARMs have been reset. More foreclosures will increase the supply of desperate sellers and decrease prices.
• There's a 'shadow inventory' hanging over the housing market; it could be vast. Everyone knew it would be hard to sell a house in 2009. Many potential sellers held back, waiting for the market to stabilize. As they put their houses up for sale, that too will hold prices down.

Some wiseacre economist has probably already come up with eight reasons why housing prices will go up. But the key thing to recall is that this is a depression...a major restructuring of the economy, not a standard post-war recession. After 64 years, the consumer has finally rung a bell. He has reached his limit. He cannot borrow more. He cannot spend more. He is finally cutting back. That fact will echo through the entire world economy...and through the US housing market...for many years.

Houses, like stocks and corpses, may bounce. But they will not begin a real bull market again for a long, long time.

Bill Bonner
for The Daily Reckoning Australia

• Housing Market is Becoming More Affordable but That’s Not Necessarily a Good Thing
• Property Spruikers Claim Australia Suffers from a ‘Chronic Housing Shortage’
• When Will Housing Stop Falling in Price?
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The "drugs" he's talking about are antibiotics, and your editor choked down the last of them this morning. Hopefully, we'll be less infected from now on. So we're going to push on and hope our mind clears up enough to figure out if the easing of one emergency can actually cause another.

We're talking about the total meltdown of the Aussie housing market, which is, after all, just a matter of time. Next Wednesday will see the release of the national accounts for June. Those figures will probably show the economy being less bad than previously expected. That might lead to the end of the "emergency setting" of the RBA cash rate at 3%, which will precipitate the decline and fall of ridiculously high Australian house prices (although this could be good for equities).

Hang on a second though. The GDP numbers will be tough to read because they're distorted by government stimulus spending, which spits in the soup of the economy. In other words, it'll be hard to tell at a glance how well the economy is really travelling on its own momentum versus how much of it is Kevin Rudd, Lindsay Tanner, and Wayne Swan with their hands on the boot of the economy pushing it down the road. Will the engine catch or sputter?

Right now, it's coughing a bit. Figures yesterday from the Australian Bureau of Statistics showed that business investment was up 3.3% in the June quarter. Most of the increase came from a 5.3% rise in investment in machinery, plant and equipment. It looks like businesses are taking advantage of Federal tax break to front-load future investment now. Whether they really need it now, who knows?

For instance, we received this note yesterday from a reader who paints a different picture:

Good Afternoon. I am a subscriber to your Daily Reckoning newsletter and thank you for this great service. I subscribe to the Grays online website for their daily online auctions and lately I have noticed a substantial increase in the amount of capital equipment auctions and often for equipment that are still under service agreement.

M.

You're welcome M. And who knew it was a bull market in forklifts!? Maybe it's not as surprising as you first think. You'd need a forklift to carry away the amount of BS being shovelled out by free-spending Keynesian politicians and the brainless economists who give them covering fire in the spineless media.

But we'll have to take it is a given that the June quarter GDP figures are distorted in a way that makes it nearly impossible to find out how well the economy is doing. That uncertainty (government intervention diminishes the quality of our knowledge because it interferes with price signals) may prevent the RBA from raising the cash rate. Or it may not. We won't know until the bank does something. Or nothing.

We've been saying all along, though, that the biggest threat to Aussie housing prices is the beginning of the tightening cycle in interest rates. The Aussie dollar was up overnight near 84 cents versus the greenback, partially in anticipation of the growing interest rate differential between the two countries. The U.S. dollar also fell against oil, which took a dip below US$70 on the front-month crude futures contract and then decided it liked it back above $70, which is just where it went.

You can take your pick of reasons for rising Aussie dollar strength...growing economy, yield difference versus the greenback...commodity currency benefitting from secular decline of the USD. But after you pick, you have to ask the next question: will the RBA raise rates because the economy here is healing? If it does, it will send the Aussie higher. But what will it do to house prices?

If you're in the real estate industry, you'll say "Nothing! House prices go up in all markets at all times regardless." But if you have a brain and use it from time to time, you would have to at least entertain the possibility that climbing interest rates and the end of the first home buyers grant spell real trouble for the housing market and the marginal buyers who support it.

The housing market requires a constant stream of new buyers and a fresh supply of credit to keep demand for mortgage finance up. That's the only way for new buyers to bridge the gap between stupidly high median house prices and real wages that are not keeping up with home price inflation. Yet as we pointed out yesterday, the government-backed mortgage finance operations are nearing the legislative limit on funding. Something is going to have to give.

Our guess is that it will be house prices. But you know that already since we've written in before. And besides, our main beat here is not property, but stocks. And it's possible stocks - on the back of more energy deals and continue Chinese demand (see Baosteel's prospective $300 million investment in coal and iron ore hopeful Aquila today) - could do a runner and sprint ahead of the property market (and bank stocks and listed property trusts at the end of their own little nice dead-cat bounce).

Don't forget gold, either. It's never far from our mind, nor our heart. Obviously the stronger Aussie dollar is bearish for Aussie gold bullion prices. On the share market side of the gold market, however, gold and explorers and producers may benefit from increased demand for ye olden yellow metal. Investment demand for gold stocks as U.S. dollar hedge is back.

Reuters is reporting that on Wednesday, ETF Securities, one of the backs of a gold metal exchange traded fund, saw its largest one-day inflow ever. The funds, "holdings jumped 7% or 211,500 ounces to 3.190 million ounces of bullion on Tuesday, from 2.978 million ounces the day before." In the last week, the fund's inflows are up 18%. Yowza.

And for those of you who began following (and suffering along with us) on the rare earth metals story, a new development today. Our story first began in June of last year when, writing a guest article at the Australian Small Cap Investigator, we tipped two Aussie rare earths shares. One was a producer, the other prospective.

Both got shellacked in the credit crunch, especially the more mature company that ran into a financing problem. But the underlying case for non-Chinese suppliers of some of the most essential and expensive elements for the modern technology and aerospace industries was still strong. Still is today, in fact. Even stronger, apparently.

The Times of London is reporting that China is ready to slap an export ban on rare earths in order to choke off any non-Chinese consumers of the elements. This affects Japanese, American, German, and South Korean companies to name a few. China has systematically and quite cleverly made itself the key global supplier of these elements. So what now?

For the consumers of rare earths, we have no idea. They are at the mercy of a limited supply. There's no such thing as just in time lanthanides production. But for punters and strategic investors who have their eye on well-shaped rare earth ore bodies in Australia, or owned abroad by Aussie-listed companies, the story is playing out quite nicely, after a few bumps and bruises at the start.

Incidentally, ASI editor Kris Sayce is having lunch with the honchos of one of the rare earths shares he follows in the ASI portfolio. It's not until the second week of September. But we're keen to read his next report on the subject.

The China strategy on rare earths is still playing out. But you see another strategy playing out in solar cells. Today's Australian reports that Chinese solar cell producers are selling their product into the global market at below the cost of production in order to gain market share and drive even low-cost producers in competitor countries out of business. Can it last?

You can sell your product below the cost of production for awhile, especially if the national government is subsidising the endeavour as part of a long-rate market strategy to own the bulk of the world's manufacturing capacity. And for consumers - provided the product quality is good - it means low prices for awhile. But it's also an unfair trade practice that could be taken up other countries with the World Trade Organisation, prior to resorting to less legalistic forms of conflict resolution.

Your editor got a note from an old friend who is running for Congress in the States. He asked, "With this current crisis and our long-term prospects bleak, why not move toward a more protectionist trade stance? Economically, what are the repercussions of attempting to level the playing field between America and countries that systematically under cut our workforce and product base? If Japan and china consistently strive to under bid is in all areas, why not close the gap at home through trade policies? Are we afraid they will call our loans?"

Our answer on Monday. Until then...we're pleased to let you know our discussion of debt and what it does to a country - its economy, housing market, and stock market - is now available on DVD with a written transcript. There was quite a bit of discussion the Aussie property market that night. So if you're interested in property, you'll want to have a look.

Dan Denning
for The Daily Reckoning Australia

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• Most People Think a Rising Housing Market Makes Them Richer

The subprime collapse is one symptom of years of little regulation, under-taxing, overspending, and massive debt. One way to understand what is happening in the United States is to look at what occurred time and again in Latin America and Asia, hotbeds of financial and banking crises. What we are living through happened time and again in Brazil, Argentina, and Mexico, as well as Korea and Thailand.

If there is too much debt, people lose confidence in the banks, then credit markets, currency, and government.

For more than a decade, the international financial cop, the International Monetary Fund, forecast a hurricane was heading toward US shores. As did many heads of the Treasury and the Fed. It is, to paraphrase a great writer, a chronicle of an agony foretold. There are five basic drivers of these crises, all based on excess: high income concentration, too much debt, too much reliance on foreign money, not enough tax revenue, and reckless government spending. Time after time governments believe they are different. They are bombarded by warnings but ignore, postpone, spend even more, and crash.

Over past decades, most US wages have fared poorly. Despite stagnant wages, consumer spending and debt increased, fueled by cheap credit. Companies also went on a debt binge. Careless deregulation allowed financial cowboys to run the system. Responsible CEOs who kept some cash, maintained moderate debt, invested for the long term, got pink slips. Financial chop shops did leveraged buyouts using a company's own cash and credit. To survive, companies piled on debt.

Many politicians decided reelection depended on cutting taxes and offering more benefits. Increase Medicare, postpone Social Security reform, hire more bureaucrats, and pay for a two-front war. Debt grew to pay for this party. These were not true tax cuts, just postponed debt; now we owe more and the bill has come due with interest.

Complicating this crisis is US economic hegemony. There were few places to park a lot of money. Despite the euro, European policies on debts and deficits are not much to brag about. So foreigners have gorged on US debt. The United States continues importing more than it exports. Middle Easterners and Asians who save and invest bought dollars for decades, but some of this money is now fleeing. The dollar has dropped sharply. Gold and oil have skyrocketed. In financial crises, huge pools of capital cross borders very quickly; a few can make a great deal of money shorting the country's currency.

The United States requires a massive restructuring to address its debt, cutting back on its borrowing, spending, and wars. The bailout package is essential to keep the credit markets open. But absent sentences that include the word austerity all the bailout will accomplish is a temporary postponement. Bailout and stimulus are a stopgap.

A solution requires the country to begin to spend what it earns, reduce its mountainous debt, and address massive liabilities, restructure Social Security, pension deficits, military, and Medicare. No wonder politicians would rather spend more of your money now rather than address these problems. Because we have been spending 5 to 7 percent more each year than we earn, a forced restructuring, triggered by a currency collapse, would have the same effect on wages and purchasing power that the housing collapse had on housing prices. So let's learn from our Latin and Asian friends and act before it is too late.

Regards,

Juan Enriquez and Jorge Dominguez
for The Daily Reckoning Australia

• Latin America Has Suddenly Become Very Interesting
• Paying Off Debt is Like Dying…
• Investment Banks Making Money Thanks to US Government Bailouts
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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

The markets are actually pretty quiet today. After battling for the better part of three months to get back in the black for the year, the Dow Jones Industrials fell 186 points in New York. We're not saying the Dow can't hold the ground it's gained. But consolidating those gains against the onslaught of more asset deflation is going to take a lot of defence.

And there's a twist today. You may be surprised with this twist, given how we've been pounding the table about the risk in U.S. Treasury bonds. We think that risk is very real and not likely to go away anytime soon, given the $3.25 trillion the U.S. will have to borrow this year. But you should pay close attention to this twist because it may explain the action in the markets for the next few months.

The twist is this: you may soon see RISING U.S. bond prices and a stronger U.S. dollar accompanied by FALLING stock and commodity prices. Yes yes, it's a complete reversal of recent trends. And it doesn't mean we are reversing ourselves about the long-term trends. But you cannot remain Orthodox if the facts change. So allow us to explain why this might happen.

Russia's Finance Minister Alexei Kudrin told journalists yesterday that the U.S. dollar is in "good shape." He added that, "It's too early to speak of an alternative [to the U.S. dollar]." These remarks came after Chinese and Russian officials have quite publicly suggested that the world's financial system would benefit from using a currency that wasn't being run by a bunch of inflationistas in America.

But the dilemma for the large dollar holders of the world-Japan, Russia, and China to name a few-is how frankly they should speak in public what everyone knows in private. By blowing the whistle on the Fed's inflationary monetary policy, dollar holders penalise themselves. After all, the rise in oil this year and the fall in U.S. bond prices are both directly related to the perceived weakness of the U.S. dollar-a face pointed out quite publicly by officials in Japan, Russia, and China.

The lesson? There's a price to pay for rightly pointing out that a huge supply of Treasury bonds threatens the credit rating of the U.S. That price is paid by owners of dollar denominated assets. Yesterday's remarks by Kudrin, then, should be seen for what they are: a hasty retreat by dollar holders to stem the fall in their investments by reassuring other investors that everything is fine.

In the meantime, you can bet that those same dollar holders are working behind the scenes to find alternatives to the greenback and, of course, to diversify their currency reserves into other currencies or tangible assets. It's just that you don't want to precipitate a crisis until you're good and ready to profit from it with a well-planned trade. Goldman Sachs would never make this kind of mistake.

A fall in stocks and commodities and a rise in U.S. bond prices are also consistent with the technical trends on the major indices we highlighted yesterday. The big bullish moves since the March lows have exhausted most of their momentum. You will now see the secondary trend, a counter rally in bonds as stocks consolidate (perhaps to be blindsided by more financial system issues later, but who knows?)

Does this mean Aussie investors ought to rush out of equities and back into property? Well, if you ask BIS Shrapnel, the answer is probably yes! Yesterday, the firm released a study that concluded Australian house prices will go up an average of 20% over the next three years. We're not making that up.

"We expect rising confidence in the prospects for an economic recovery in 2010, so investors are likely to return in greater numbers, attracted by increased rental returns and low interest rates," says BIS Shrapnel senior project manager Angie Zigomanis, who was apparently not informed that Australian banks have begun raising home loan rates.

Blah blah blah. Yammer yammer yammer. Lies lies lies.

Well, okay. Maybe not lies. And to be fair, the BIS report actually admitted that the inflation adjusted gains in Aussie house prices, should they actually materialise, would actually be about half the nominal figure. You'd have something more like a 9%-11% gain over three years, or about 3% compounded after inflation-which is about seventeen percent smaller than twenty.

Even three percent a year seems generous to us, given that Aussie unemployment is still rising. More importantly, the low point of the interest rate cycle has been reached. It's hard to see how that's bullish for housing-unless BIS is right and investors dump shares and try to lock in new financing before interest rates rise even further (double digits by 2011, we reckon).

And let us not forget that first home buyers accounted for 28% of all new housing finance in April, according to the Australian Bureau of Statistics. That's the highest percentage since 1991, the ABS added. The first home buyers aren't just a marginal force in the market any longer. The lure of government grants has sucked them into the residential property market at a peak in prices and a low point in interest rates. They may be propping up the market now. But when their financial strength fails, it could crush them AND the rest of the market too.

This is simply a disaster waiting to happen for the unlucky first homebuyers, as we've said before. Nor does it bode well for the rest of the residential property market. Real estate agents always tell you that the sooner you get on the housing ladder the sooner you can move on up. Buy a house, sell it. Buy a bigger house, sell it. Buy an even bigger house, and so on. There are many mansions in Australia's property market.

What happens, though, if the lowest rung on the ladder is violently ripped off? If you bring forward years of demand by first home buyers and concentrate all that demand into a thirteen-month period (October of 2008 through the end of this year) what will happen? Hmm.

Well, for one, you will have structurally altered demand for housing finance for years to come. Eventually there's going to be a drought of new buyers who cannot get credit or cannot afford to get on the ladder without a $30k boost from the politicians. But even that is an optimistic view.

The more negative view is that a large percentage of the FHBs who've come in on the current grant package are going to get wiped out. They will be renters for a long time to come. This removes them from future demand for housing finance too.

And so who will investors low on the ladder sell to? Who will people on the second rung of the property ladder sell to if there's no one from the first rung looking to climb up? And if people in the middle of the housing market can't sell to trade up, where will demand and the top end come from?

Maybe we're wrong. We often are, and will be again (and again). But we suspect that the government's policy to bring demand forward at the bottom end of the market will destroy future demand at ALL levels of the market. And one more point about housing. Quit sending in e-mails telling us it doubles every ten years.

Seriously. Stop it. We're tired of reading them. Housing does not double every ten years. That is simply not true.

To get the doubling time for any investment you divide the interest rate you're getting by 72. This is known as "The Rule of 72". For example, an investment earning seven percent per year compounded would double in 10.3 years (72/7=10.28). You can see how absurd it is to suggest that it's possible for housing (or any investment really) to grow infinitely at a rate of 7%.

By the way, if you want to see more on inherent possibility of exponential growth-and you are not easily bored-give this video a try. And after reading it, tell us if you agree or disagree with the following statement: a fiat money system accelerates the depletion of resources and the misallocation of capital.

Hey did you see the government of New South Wales has come up with a nifty new policy of buy Australian? The Rees government has said that NSW government departments and agencies have to give preference to Australian-made products when buying uniforms, cars and even trains, according to Sydney's Daily Telegraph.

It's not exactly a Smoot-Hawley tariff war to kick off the next Great Depression. But in principle, this is an equally stupid policy. It's again a case of what is seen versus what is unseen. What will be seen? The jobs that go to Australian companies that make these things.

What is unseen? The cost to NSW taxpayers will most certainly be higher to "buy Australian." The government will pay more for these things, leaving it with less money to pay for other things. Or, it will raise taxes in order to pay for the higher spending, and the higher taxes leave New South Welshmen with that much less to spend on other products.

Either way, someone always pays the price when the government favours one group over the large group. About the only compelling argument for this kind of policy, in our opinion, is that competition for these goods or services from China (and that's who this targets) is "unfair."

That is, if the Chinese-or any other labour market for that matter-are using slave labour to produce goods, it's a sound principle not to buy those goods. But if it's not a moral issue and is just an issue of economics, the relevant question is whether these goods and services can be produced in Australia at competitive prices.

We suspect that for industries like textiles, the answer is simply no. Australia, like so many other Western countries, can't compete on labour or raw material costs with lower-cost manufacturers. Where Western post-industrial economies ought to be able to compete is on quality.

Consumers will always pay more for superior quality for certain goods (textiles, electronics, and manufactured goods). In fact, Japanese and Chinese consumers seem to love French luxury goods, as we recall from our time dodging them outside the shops on the Rue de Rivoli in Paris.

The point is that Western firms can carve out a niche in high-margin manufactured goods and even textiles, provided the quality is excellent. But it's not something you can do simply be changing a government policy. You have to compete. In the meantime, while we're measuring how many jobs the NSW policy saves, can we also measure what the higher costs mean to everyone else in NSW?

Finally, we were going to tell you about the Zombie war today. But we've run on too long already. More on that from our friend Shawn Cownah tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Rule Scrapped: Banks to Value Assets Using Mark-to-Market
• Aussie Housing Market Actually Leads the U.S. by Three Years
• Australian Housing Market Getting Stronger Despite Fear of Inflation
• Housing Mistakes Embarrass the Rich
• Underlying Demand During a Housing Shortage

Gold, however, took a big hit - minus $26.

There are three kinds of money in the marketplace. There's the smart money that goes with the trend. There's the dumb money that bets against the trend. And there's the money that doesn't know whether it is coming or going.

The trouble is always figuring out which is which.

The markets are clearly in a deflationary downturn. No doubt about it. After a long period of credit expansion credit is finally contracting. The smart money is probably betting on lower asset prices.

"Consumer credit falls the second most on record," reported Bloomberg last Thursday.

Houses, as everyone knows, are deflating. There are signs that the fall in housing prices is becoming less violent, but the trend is still down.

This from Robert Shiller, in the New York Times:

"Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.

"There are many historical examples. After the bursting of the Japanese housing bubble in 1991, land prices in Japan's major cities fell every single year for 15 consecutive years.

"Why does this happen?"

Shiller goes on to explain that housing markets don't adjust quickly. People make their housing decisions years in advance...based on changes in their lives. They may have found a job somewhere...or gotten a divorce...or their children may have left home...or they might just want to live in a different area. These plans take years to come together...and years to execute. They can be reversed by changes in market conditions...but not quickly.

And then, when people are planning to sell a house, they may not be in a hurry. If prices slip, they may decide to hold off - maybe for years.

Then too, decisions about buying or selling a house are often decisions taken by two people together. The husband may be desperate to get out of a sinking housing market, for example, but the wife may not want to leave her home. Even when they must sell for financial reasons, that decision can take months...even years...to reach. Often, they hesitate. The wife expects to get a better job...or the husband expects a raise...or they anticipate some other economic change in their lives that would forestall the need to sell their house.

Then, after the decision is made, there's the actual process of selling a house -- setting a price...and finding a willing buyer. In a downward market, buyers' expectations tend to adjust most quickly. Reading in the paper about a correction in the housing market, the prospective buyer expects a great deal. The prospective seller, on the other hand, tends to deny the severity of the downturn. He reluctantly and belatedly acknowledges that he'll need to lower his price. But as he gives in the market gives way further. The prospective buyer hears about more great deals that other buyers are getting...and he lowers his price targets even faster than the sellers lower their asking price.

Shiller gives another example...

"An elderly couple who during the boom were holding out against selling their home and moving to a continuing-care retirement community have decided that it's finally the time to do so. It may take them a year or two to sort through a lifetime of belongings and prepare for the move, but they may never revisit their decision again.

"As a result, we will have a seller and no buyer, and there will be that much less demand relative to supply - and one more reason that prices may continue to fall, or stagnate, in 2010 or 2011.

"All of these people could be made to change their plans if a sharp improvement in the economy got their attention. The young couple could change their minds and decide to buy next year, and the elderly couple could decide to further postpone their selling. That would leave us with a buyer and no seller, providing an upward kick to the market price....

"Even if there is a quick end to the recession, the housing market's poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997."

We're also looking at $2.4 trillion worth of Alt-A mortgages that will need to be refinanced or reset. The peak in those resets won't happen until January 2013.

Stay tuned...this housing bear market isn't going away any time soon.

Housing is wealth for America's middle class. As long as housing is going down - or even NOT going up - the middle class is going to feel poor. It has the huge debts that it built up during the credit expansion...and it has to pay them, even though it has 1) falling incomes...and 2) falling assets.

The smart money is probably betting that this deflationary correction has further to go...probably much further to go.

But against this natural, normal -- and probably inevitable -- market trend are the hopes and fantasies of an entire generation. The baby boomers have staked their futures on continuing EZ credit. So have their leaders. And so now, the feds and the voters are of one mind. Both want to stop the market correction AT ALL COST - especially if they can lay the bill onto the next generation.

Now, here's where it gets interesting. Because the dumb money is probably betting that the feds can make this work. That's what all this talk of "green shoots" is about. A huge part of the public believes that the 'worst is over'...and that the feds' policies are working. They're buying stocks in the belief that this is a recession just like any recession of the post-war period. Ben Bernanke says it will be over by Christmas; they believe him.

Meanwhile, there are some very smart people who think the feds' efforts not only won't work...but will create an even bigger disaster. Those people are buying gold...and commodities.

David Einhorn, the hedge fund manager who foresaw Lehman Bros. going broke, is now buying gold. John Paulson, who made billions by being right about the credit crisis, is also buying gold. The Chinese are buying gold. So many smart people are buying gold coins that they have become hard to get.

What's our view? Who's right? The dumb money; the smart money; or the very smart money?

They may be all right...but at different times. This rally could last a while longer. Then, prices will probably resume their downward path...and then, eventually, inflation fears will send gold soaring.

We continue to answer the question - "will we have inflation or deflation" - in the positive. 'Yes,' we say, 'both of them.'

The markets must fully express themselves - which means they need to bounce...and then take the stuffing out of asset prices. Today's asset prices represent yesterday's economic calculations. The value of a house, for example, depends the economic conditions of the bubble period, 2002-2007...and on the whole swell of the great post-war credit expansion. That house price is now adjusting to the post-bubble era...when people have lower living standards and less expectation of a rising housing market. That adjustment will take many years and eventually leave house prices probably 20% to 30% below where they are today.

But the feds must fully express themselves too. They're bound and determined to cause inflation. They believe the country's financial future depends on it. It may take them a long time to get the upper hand in their war against capitalism...but eventually, they will do it. And eventually, the very smart money will be proven right - when the dollar collapses...and gold goes up.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• When Will Housing Stop Falling in Price?
• Two Ways to Deleverage an Economy
• Investors Feel They Can Put Their Money into Treasuries and Not Worry
• Dumb Money Eyes Stock Market While Smart Money Watches Economy
• The Interest Only Mortgage Option

The volume figures suggested Monday's rally was broad but not deep. On Tuesday, that was confirmed. In Australia, the All Ords finished up but couldn't match the 7% surge on the S&P 500. Financials like Macquarie Group (ASX:MQG) and Westpac (ASX:WBC) were the big winners on the day.

Today is another story. Stocks in New York were down. And investors now have to figure out just what this Geithner plan means for the banking system. That is a question we'll deal with today, too. It's a big one.

But first, there's more news on the housing front to report and argue about. Remember, all we're saying is that rising Australian housing prices had a lot more to do with the credit boom than any critical shortage of housing stock.

This alleged shortage is often alluded to but never proven, so far as we can see. If someone does have proof, we're happy to publish it. But if there were really a shortage of housing units, wouldn't there be a lot more people living in the streets or in their cars?

The main reason we're harping on the topic is that Australia is showing the same social and psychological symptoms of housing infatuation that we saw in America in 2004. It's a love affair. Or a disease. Or both. But the point is that turning to property as an antidote to the share market poison may not be your best bet.

While the great youth Binge on Housing unfolds, one statistic to watch is how many new housing loans are going to first home buyers. Before the U.S. housing boom went manic in 2004, subprime loans accounted for about nine percent of all new mortgage originations in the U.S. Then-after the Fed lowered short-term interest rates to one percent and kept them there for a year-non-bank lenders went down the credit ladder looking for new marks.

At the height of the boom, subprime loans as a percentage of all new mortgages rose to 25%. In certain states like California, subprime loans started to account for an even larger percentage of all new loans made. The low rates even induced a lot of borrowers with fixed rate 30-year mortgages to refinance into a subprime or adjustable rate mortgage.

Getting the marginal buyer into the housing market keeps the bubble going. But it's also the last phase before the bubble pops. So keeping an eye on an influx of marginal buyers into the market is one way of alerting yourself to potential falling house prices.

Earlier this month the Australian Bureau of Statistics reported that, "The number of first home buyer commitments as a percentage of total owner occupied housing finance commitments increased from 25.7% in December 2008 to 26.5% in January 2009. This is the highest level recorded since the series commenced in 1991."

These would be the First Home Buyers (FHB) taking advantage of the Kevin Rudd's enlarged first home buyer grant ($14k for existing properties and $21k for new homes). And if you dig a little deeper, you find that more of these new borrowers are borrowing more with 'honeymoon' introductory interest rates that later reset to standard variable rates (exposing them to rising rates, probably in 2010 or 2011, more on that below).

So the first problem we have is that marginal buyers are becoming a larger percentage of the market. The second problem is that they are borrowing more. According to the Australian Finance Group, loan-to-value ratios were 66% in September of 2007. They're now at a new high of 72.7% nationally (75% in Victoria and 76.6% in New South Wales).

What's more, the number of new buyers choosing the low introductory 'honeymoon rates' has grown from 5.3% of new lending to 21.8%a 311% increase. And according to industry outfit Mortgage Choice, 92% of new mortgage loans in Australia are variable rate.

We provide this litany of statistics to make a simple point: the marginal buyer at the most risk of losing his job and with the fewest assets and facing the highest mortgage stress is borrowing ever larger amounts of money at variable rates at the low phase of the interest rate cycle. He has maximum exposure to falling house prices and rising rates.

Of course, you could argue that interest rates have reached a permanently low plateau. You'd be a moron if you did so, but you're welcome to it. It's much more likely that interest rates will begin to rise in 2010 or 2011. Why?

Well, by then you will either have inflation as a result of more stimulus packages, deficit spending, and an expanded money supply. Or if you prefer a positive scenario, a recovery will taken hold by then and the RBA will be forced to raise rates to "cool things off."

Another scenario we won't go into in massive detail is that China may be blamed for inflation by then. This came to us via a reader but it makes sense so we'll mention it briefly. The theory goes that massive multiple government stimuli will have worked their way into the economy as bank lending by later this year or early next.

This will lead to inflation, which naturally will shock (simply shock) policy makers. So they will blame China. You know, the China that's been busy stockpiling resources and tangible assets, while getting rid as many of its dollar reserves as possible, as quickly as possible.

That's largely a geopolitical issue, and could lead to some intriguing fireworks next year. But economically speaking, it means about a year from now, FHB's are going to find out that interest rates rise as well as fall. Kevin Rudd better hold the election before then. If he doesn't, no amount of love from Barack Obama may save him from a mob of angry, disillusioned, and heavily indebted Gen Yers.

While we still have China on the brain, did you see the speech by Zhou Xiaochuan of the People's Bank of China on the need for a new international reserve currency that is not the U.S. dollar? It was a Jim Dandy of a speech.

He said a lot of provocative things in the speech without ever mentioning the U.S. dollar by name. But the key line for us was the realization that money not backed by a real asset or real collateral is not real money.

Zhou said, "The acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history. The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability."

The speech mentions a few possibilities for replacing the dollar, some of which include using a basket of other currencies and commodities. But don't expect anything to happen soon. As troublesome as the dollar standard has become to everyone, it's not the sort of thing you swap out like a bad light bulb.

What's more, an international reserve currency would have to be managed by someone or some organisation other than individual national governments. That's pretty unlikely. Why?

National governments would be extremely reluctant to give up the ability to devalue their own currencies in order to support exports (see Asia). Also, the strategy of deliberate inflation is a time-tested government method of delivering phony prosperity by expanding the money supply. To give up that ability is to give up the power to create illusions of wealth. Incumbent governments would get the boot from voters for not magically creating more money and giving it away. Avarice.

Also, do you sense a little bit of whinging on the part of the Chinese now? They are worried about the value of their dollar holdings. But the Chinese also deliberately kept the Yuan from appreciating versus the USD over the last ten years. They are every bit the currency manipulators that the U.S. government has become.

China's artificially cheap yuan perpetuated its low-cost labour advantage across the globe. It kept Chinese goods cheap overseas and allowed Americans (flush with credit and in high spirits over the housing boom) to go an epic spending spree.

Now China has all its foreign currency reserves in the dollar basket. And that basket is on fire, so its leaders are belly aching (albeit it dignified fashion). If anything, yesterday's announcement could have been targeted at the rest of the G20 nations as a plea NOT to sell the dollar. China saying, "Yes, this sucks. We're aware of it. We need something different. But not just yet."

One other note regarding China. How suicidal have American policy makers become? By devaluing the dollar they accomplish two things: they cheapen the dollar's purchasing power on international markets and lessen the appeal of U.S. financial assets to foreign buyers.

This makes it harder for the U.S. to finance its massive deficits AND it means Americans are competing for scarce tangible assets on the international markets with an increasingly weak currency. Nice work boys!

Okay. Finally. The Geithner plan. What more can we say about it that hasn't already been said?

Rather than going into the details of the plan we'll just tell you what we think: it's a big cop-out by the Feds and a big power grab by the money centre banks to avoid their day of reckoning for making a massively bad bet on U.S. housing prices.

The upside for the banks is that the plan may just help them avoid insolvency. For investors, there is no risk to participating in the scheme designed by Geithner. Because the FDIC provides financing and the Treasury the Equity, private capital interested in the deal has to pony up only a little capital to be exposed to any upside in the toxic assets.

And the downside? That belongs to the FDIC and by extension, the U.S. taxpayer. So with that kind of deal, it's no wonder Bill Gross and others are excited to have a punt. Why wouldn't they?

The flaw in the plan, as others are beginning to point out, is that its basic assumptions are wrong. It is trying to fix a fictitious problem. In Geithner's world, the U.S. banking system is basically sound. But these prodigal assets, these mortgage backed securities are impairing the ability of banks to loan.

The Geithner plan assumes that the problem with the assets is not the collateral that underlies them (subprime loans made to delinquents), but with the pricing of the assets. So he's invented a scheme that creates an artificially high price for the assets that brings together an unwilling seller (the bank, who must not take too large a loss on the assets or it will see its equity destroyed) and an unwilling buyer (private equity and hedge funds).

Will it work? Well, it may clear the assets off bank balance sheets. That itself doesn't guarantee banks will resume lending. Lending to whom? To all those people wanting to buy a house? To all those Americans terrified of losing their jobs? And let's not forget, the whole plan assumes there will be no further deterioration in still other securitised assets held by banks. That's a big assumption.

In any event, the plan reveals part of the spirit of our age: the belief that there are no real or lasting consequences for being wrong or for moral mis-behaviour. It's as if once the assets are gone, the same bank managers and risk takers who made a huge directional bet on U.S. housing can get right back to business as usual, forcing U.S. tax payers to pay (for years) for their mistakes.

The truth is the U.S. money centre banks have a huge amount of political power. They donate and contribute to the campaigns of the clowns in Congress who pretend to regulate them. The stockholders and bondholders in these institutions should be forced to realise their losses as punishment for the bad investment they made in U.S. housing. That's how markets ought to work (and that's what makes them fair).

But the whole thrust of the Obama/Geithner team is to protect bondholders and stockholders and punish taxpayers. It also punishes the many regional banks that did not make bad sub-prime bets and did not receive billions in unaccounted for TARP money.

The alternative is to place the big banks in receivership. It allows them to stay in business while the assets are liquidated, new capital adequacy ratios are instituted, and new regulations put in place on the amount of leverage depository institutions can use in their proprietary trading.

But none of that looks like it's going to happen. It's as if nobody did anything wrong and the assets themselves are to blame for being wayward and underperforming. The Washington/Wall Street axis refuses to acknowledge and take the loss for a huge misallocation of capital. And so the rest of the country and the rest of the world will pay the price by way of higher inflation and later, nationalisation.

As Matt Taibbi wrote in this month's Rolling Stone, "In essence, the bailout accelerated the decline of regional community lenders by boosting the political power of their giant national competitors. Which, when you think about it, is insane.

" What had brought us to the brink of collapse in the first place was this relentless instinct for building ever-larger megacompanies, passing deregulatory measures to gradually feed all the little fish in the sea to an ever-shrinking pool of Bigger Fish. To fix this problem, the government should have slowly liquidated these monster, too-big-to-fail firms and broken them down to smaller, more manageable companies. Instead, federal regulators closed ranks and used an almost completely secret bailout process to double down on the same faulty, merger-happy thinking that got us here in the first place, creating a constellation of megafirms under government control that are even bigger, more unwieldy and more crammed to the gills with systemic risk.

"As complex as all the finances are, the politics aren't hard to follow. By creating an urgent crisis that can only be solved by those fluent in a language too complex for ordinary people to understand, the Wall Street crowd has turned the vast majority of Americans into non-participants in their own political future.

"There is a reason it used to be a crime in the Confederate states to teach a slave to read: Literacy is power. In the age of the CDS and CDO, most of us are financial illiterates. By making an already too-complex economy even more complex, Wall Street has used the crisis to effect a historic, revolutionary change in our political system - transforming a democracy into a two-tiered state, one with plugged-in financial bureaucrats above and clueless customers below.

We'll leave the last word today to investor John Hussman: "Make no mistake - we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own.

"All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns' bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans.

To be continued...

Dan Denning
for The Daily Reckoning Australia

• Geithner and His Toxic Asset Bailout Plan
• Deleveraging Will Give Us a Bout of ’30s-Style Deflation
• When Will Housing Stop Falling in Price?
• Fed Will “Monetize the Debt”
• Aussie Housing Market Actually Leads the U.S. by Three Years

The First World War: 1914-1918. The First World Depression: 2009-??

"This is going to be even worse that I thought," said our old friend, Doug Casey.

He was referring to what will most likely become the world's first global depression.

"What happened while we were away?" was the question we had asked.

We just got back from our trip out to the ranch. What do we find? More of the same:

The Dow fell another 312 points on Friday. The index now stands at 8379. This morning, stocks are falling again in Asia.

In Japan, the Nikkei index finished down 6.4% - its worst closing level since October 1982. Shares in Hong Kong didn't fare any better; with the Hang Seng index falling 12.7%.

And at the open this morning, the Dow is down over 150 points, as confidence in the U.S. government to help quell this global depression is further shaken.

'Dow 5,000' is our prediction. Not that we have any inside information. But when we look at a long-term chart of the Dow, we notice that it goes up and down. It tends to go way down after it has been way up - in long, 15-20 year waves. The top of this wave washed over us in January 2000. Since then, the index has been higher...but not when you adjust it for inflation.

It probably would have corrected to the 5,000-range already. But the feds intervened. And now we've really got trouble. Because in trying to head off a recession/bear market, the authorities provoked a housing bubble, a financial bubble, and a worldwide credit bubble. Homeowners over-bought. Banks over-lent. Consumers over-stretched. Almost everyone seemed to over-do it. So, what might have been a typical bear market has been transformed into a monster of deleveraging.

The planet's financial press is beginning to see things our way. "In the first place, the U.S. federal reserve applied a very expansive monetary policy." This is a quote from La Prensa in Buenos Aires. The article goes on to explain that a combination of fiscal and monetary stimulus in the early 2000s produced a huge party in the financial sector, with most of the liquor coming from residential mortgages. Banks all over the world got in the bubbly spirit. Too bad. Now, they're all reporting in sick and calling the doctor.

The paper does not point it out; so we will: The world's worst headaches will be felt by America's baby boomers.

"I don't know what they're going to do," said another friend over the weekend. "I know I'm in good shape. I've saved a lot of cash. I began reading The Daily Reckoning about two years ago...and actually started following your advice. I sold almost all my stocks. I'm in cash in and gold. I don't even have a mortgage.

"So I don't have too to worry about. But I'm worried anyway. I don't know...maybe it's just catchy. I'm cutting back as much as I can. For example, I was going to buy a new car. I went in the showroom and picked one out and everything. But I think I'm going to cancel the order. Well, the salesman's not going to get his commission. And I'm going to start doing my own yard work. It's silly in a way. Because I don't have to. But it makes me nervous to spend the money. Which means, there's some minimum-wage guy who's wages are about to become even more minimal. And I figure that if I'm thinking that way, there must be millions of other baby boomers in worse shape than I am and they're probably cutting back as fast as they can. Businesses have got to be cutting back too. And when employers look for fat to cut, they're bound to find the baby boomers. And then what do these people do? They don't have savings. And they're not likely to get another job...not in a major downturn. It could be pretty grim all around."

The latest report says unemployment in Rhode Island has topped 9% - the highest rate in the nation.

"But this has barely begun," continued Doug. "The real cuts only began a few weeks ago. They don't show up in the figures yet. All this takes time. First, it was only the bankers who were panicking. Then, it was investors. Now, it's businessmen. And soon, it will be consumers. This kind of crisis runs downhill."

Investors had plenty of reason to panic. This month alone, stocks worldwide lost $10 trillion. The world stock index is down 48% so far for the year.

Businessmen have reason to panic too. They'll have a hard time raising money in this market. So, they have to cut new projects and old employees.

The next stage will come when consumers go on a rampage of thrift. Credit cards will go in the trash. Malls will be silent. Sales clerks will fall asleep on the job - and then be fired. Higher unemployment. More foreclosures. More bankruptcies.

And when Americans don't shop, it will be products Made in China that they aren't shopping for. That's why the depression will be worldwide - the first ever.

"China, India, Brazil and Russia (the BRICs), the biggest emerging economies, export most of their products either to each other...or to the developed economies [mainly, the USA]," continues La Prensa.

Yes, dear reader...our "Crash Alert" flag is still up-even though the stock market, the housing market, the financial market, and the commodities market have already crashed. But now, there's another flag up on our mast, a black flag. On it is a white duck laying on its back with its feet up in the air.

It is our way of warning you: "Global Depression Alert" it says at the bottom.

*** Asked about the commodities market, our old friend Rick Rule had this comment:

"There's going to be a very interesting tug-of-war. On the lower side will be, I think, rapidly declining developed-nations demand. Meaning recession in the United States and Western Europe. And on the other side is going to be, I think, steadier emerging-market demand than many people think. Simply because the developing countries' balance sheets are better than we are accustomed to.

"I think the very sharp moves down in commodity prices are over. I think that those sharp moves down were not a reflection of fabrication in consumer markets. But rather, [they were] a function of financial players that were involved in the new carry trade involving low U.S. dollar interest rates where people were going long commodity, short the U.S. dollar; a trade that worked for a year and unwound very, very, very aggressively. So I think the sharp down move that we've been through is in some part over. I think it's likely to be replaced in the base metals by a grinding move lower. It probably will not be particularly deep but maybe four to six months longer in duration."

(Look for more comments from Rick in our upcoming report on the crisis and how to survive it...coming soon...promise!)

*** "It's better not to watch," said a friend over dinner.

We've been out of touch with the financial world for a couple days. Up at the ranch in Argentina, we have neither phone, nor TV, nor Internet.

"You're better off not paying any attention to it anyway," continued our companion. "All markets go to extremes. And then, when they get to their extreme position, everyone tells you that 'this market won't go down.' And they always have a lot of reasons why they won't go down. As soon as you hear people explaining why this market is different, it's time to get out.

"But the trouble is, even if you know it's a lot of nonsense...and even if you know prices WILL go down... all those people with all their stupid 'reasons' have an effect on you. You may think it is crazy...but you begin to think that there are so many crazy people out there...maybe it will go on forever. And so you don't get out when you should. You say to yourself: 'well, only a fool would buy at these prices...but there are a lot of fools around... I'm going to sell...but not quite yet.'

"That's why it's better to cut yourself off. Just look at the facts yourself. And if you think it is crazy, it probably is crazy. And you should get out, now. What was it that J.P. Morgan said? 'I've made a fortune by selling too soon.'

Dear readers are warned:

First, we don't know any better than anyone else how this bear market will play itself out.

Second, it is quite likely that there will be a biggish rally that will convince people that the whole thing will blow over. We hope there is a biggish rally; we intend to use it to sell out of stocks completely (a confession: we're better at giving advice than taking it - even our own advice.)

And third, Warren Buffett is no fool; if he says you should buy stocks, you should at least listen.

Listen politely...but get out of the stock market anyway.

*** We come to Argentina partly to check on our cabbages...and partly to get a look at the future. Bankruptcy. Default. Hyper-inflation. As our dear reader commented earlier in the week, the average Argentine cab driver knows more about financial crises than the heads of the U.S. Federal Reserve and Treasury Department combined.

What have we learned? More tomorrow...

Bill Bonner
for The Daily Reckoning Australia

• Feds Have Used the Correction to Increase Their Power and Add to Their Wealth
• Capitalism Has to Do its Work
• Bailout Rejected by the House
• The Day of Reckoning is Upon Us
• Stocks, Bonds and Economy All Bounce