We spent Sunday with the publisher of International Living magazine.

"Prices have fallen so much in Florida that you really get more for your money there than practically anywhere else," she continued.

"I think Florida may be cheaper than Buenos Aires," added son Will, who's been living in Argentina for the last three years.

Housing is cheap in the United States. In Texas and Arkansas, housing is probably the best bargain on the planet. Food prices are going up; still food in the US is much cheaper than it is in Europe. And cars? We have a friend in Paris who goes back to the US to buy his Mercedes. Even with the cost of shipping the car back to France...and the cost of refitting the car to European standards...he still saves about $10,000.

"I was just in Paris," Will continued. "You pay $10 for a cup of coffee and a croissant. In Florida, I can get the 'Breakfast Special' for $5.95...and it has everything. Pancakes. Bacon... Everything."

"But what is amazing," continued our International Living colleague, "is that interest in moving overseas is going up. It's not about money. Apparently, a lot of Americans are just fed up...or afraid. They want to get out. They see taxes going up or they see the society going down the tubes. I don't know. But many say they just don't like the way things are going.

"One thing I hear is that they think American society has become meaner...ruder...less civil. You can't have a polite discussion of politics anymore. People get really upset and nasty. I mean, someone yelled out and called Obama a liar in the middle of a joint session of Congress. And a substantial part of the US population regards the guy - the guy who called him a liar - as a hero. They think Obama is a traitor...

"I think this is really a result of the financial downturn. People feel betrayed. Let down. They think something is very wrong. That the nation is in decline. So they look for someone to blame. And they tend to blame each other. Conservatives blame liberals. Liberals blame conservatives. They blame the bankers. They blame the capitalists. They blame the government.

"I guess that's what happens when you get a major correction or a big financial crisis."

We recalled what happened in Germany in the '20s and '30s:

"Germany was probably the most civilized country in the world - before WWI. Artists, philosophers, scientists, mathematicians, musicians... Germany had the best in the world. The war shook the public's faith in its leaders. But then, according to people who lived through the period, the financial crises of the '20s and '30s were worse. Hyperinflation...depression...strikes...a decade of financial chaos and disruptions led to a breakdown in social order. By the early thirties, groups of communists and fascists were battling in the streets. People seemed to leave the center and move to extreme positions. Soon, the Nazis had the upper hand and Hitler was voted into the government."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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• The Crime of Central Banking

It's back to business. No more long lunches. No more afternoons painting windows. No more soirees in the evening.

We return to our lonely métier - chronicling the decline and fall of the US economy...and the Anglo-American empire too....

Two bits of news signal the scale of this trend. But first, here's one two-bit piece of news: the Dow lost 185 points yesterday. Could this mark the beginning of the end for the rally? Yes, it could. Should you be out of US stocks? Yes, you should.

But let's turn back to our 'decline and fall' chronicles...

From Florida, comes news of the first drop in population in 60 years. "Unemployment is soaring," reports USA Today. "Florida is second to California on foreclosures."

Yes, dear reader, there is trouble in the sand states...

Florida lost a net 58,000 people this year...for the first time since the 1940s.

Why would that be? We'll take a guess. Florida is a state where people go to retire. It is where people go when they stop producing and begin consuming. The major industry in the state was housing...building houses for consumers!

But now, the turn has come. Fewer people have money to consume. And those who do are keeping their money in their pockets. We even saw a report in The Wall Street Journal that people are cutting their own hair to save money. They're also staying put, rather than moving to Florida. So Florida needs fewer new houses...and fewer people to build them.

Second, from national income statistics comes a report that the typical US household has less discretionary spending than at any time in the last 50 years. Why? Americans have no money to spend because they already spent it! Now they're paying the price. And it will take years - maybe 10 years, maybe longer - before they've paid down their debts to more comfortable levels. In the meantime, they are poorer than they've been since the Eisenhower years.

Keeping it simple: Our view is that there is a major transition underway. There will be no genuine recovery, not now...not never. That is not to say the world economy is doomed to perpetual darkness and misery. Not at all. What it's doomed to is a long period of adjustment...with high unemployment, on-again, off-again recession, and desperate efforts by the feds to return to the good old days of the bubble years.

But there's no going back. It was as if the economy was playing a game of Russian roulette...and then the pistol went off - the debt bubble blew up. Once the bullet left the chamber, the game was over. Recovery? Forget about it. The old economy isn't going to bounce back; it's dead.

Still, just because a thing is hopeless doesn't make it unpopular. The feds are fighting the correction every step of the way. They're propping up brain-dead companies...and keeping zombie banks going by feeding them the blood of taxpayers. It's ghoulish...it's a very scary movie!

Unfortunately, the ghouls vote! And everywhere the feds look there's a campaign contributor or a lobbyist or a voter...and they all want the A-positive blood of taxpayers. They look to the feds for a transfusion in order to keep living in the style to which they've become accustomed...

Just what you'd expect, in other words. And with so much debt in the system, the feds are desperate to raise inflation levels. They must increase the CPI to persuade consumers to spend money rather than save it. Otherwise, the nation risks falling into a deflation trap - the very thing Ben Bernanke has pledged to avoid. So they'll continue going down that road - towards inflation - until they finally get there. And they'll keep pressing harder and harder on the monetary accelerator until they finally run into a tree. Again, just what you'd expect.

So, where's the surprise? We're on the road to destruction; that's clear. But it may be a much longer road than most people expect.

Ambrose Evans-Pritchard in London's Telegraph:

"'The current financial crisis is unlike any others,' says the Bank for International Settlements. Lasting damage has been done. The 'cumulative output loss' is likely to reach 20pc of GDP in the major economies.

"The message is the same at the International Monetary Fund. 'The world is not in a run of the mill recession. The crisis has left deep scars. In advanced countries, the financial systems are partly dysfunctional,' said Olivier Blanchard, the Fund's chief economist.

"It has certainly alarmed US retail tycoon Howard Davidowitz. 'As a country we are out of control, we're in a death spiral,' he said.

"Jeff Wenniger from Harris Private Bank says an army of baby-boomers have seen their old age plans shattered by the housing bust. Their nightmare is here. They will have to spend less, and save more. 'Generational destruction of a society's balance sheet will not rectify itself in a matter of months.'

"'How about a quarter century?'"

Bill Bonner
for The Daily Reckoning Australia

• Economy Not Going Back to Normal Any Time Soon
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• Feds Want to Increase the Money Supply and Induce People to Spend Money
• Should You Buy Gold Now?
• Until This Debt is Reduced, Americans Will Be Reluctant to Borrow or Spend

We assumed there must be such research in existence. After all, it is the main basis the property bulls make to support the idea of continually rising property prices.

They further argue the shortage is magnified due to immigration and natural population growth, so that there are not enough houses being built to accommodate everyone.

That should make you think that data supporting the argument is easily available.

Well, you're right. It is easily available.

However, we can only think that no-one has ever read it.

Because if they have, they could not possibly conclude that there is a 'chronic' housing shortage.

The numbers which represent the entire basis for the 'chronic' housing shortage just don't add up.

Shortly, I'll show you once and for all that Australia does not have a 'chronic' housing shortage. Further, I'll show you that as soon as government runs out of ways to manipulate the housing market, prices will collapse.

To be honest reader, your editor is almost speechless. For years we've heard the argument about demand being far in excess of supply.

We've lost count the number of times the likes of Christopher Joye, Rory Robertson and the Housing Industry Association (HIA) have told us about the shortage and how this is the reason why property prices cannot fall.

But the one thing that always struck us was the lack of referenced evidence. We've hardly ever read one of these 'experts' point towards ironclad proof.

Sure, plenty of times we've read vague numbers being thrown around. As if merely saying there's a shortage and then applying a number to it is somehow proof enough.

Well, last Friday we decided enough was enough.

On a whim I wrote to Money Morning readers to ask for help:

"Aside from yourself, there are now about another 40,000 people who receive Money Morning every day. I know for a fact there are property bulls and bears among the audience.

Therefore if you have access to authentic research which identifies the 'chronic' housing shortage in Australia, please email to the Money Morning mailbag at: moneymorning@moneymorning.com.au

I would be glad to read it and I'm happy to publish the highlights."

I soon wondered what kind of response I would get. I also wondered why I hadn't simply 'Googled' for it. Was your editor being lazy? Or could we just blame it on being a Friday?

Well, the responses we received made us realize the following...

First, it was laziness. A simple search on Google would have given us the information we needed in a flash.

Second, we thank Money Morning readers Laurie and Rob. Both of them provided the link to the research that is the basis for the 'chronic' housing shortage argument.

Here's the link to the report.

It's 193 pages long, so you may want to brew a cup of tea and tell your receptionist to hold all calls for a few hours.

But even before you get out of the Executive Summary on page xiv you're hit with a giveaway to how unreliable the data in the report is:

"The Council stresses that projections beyond two years are speculative..."

Two pages later:

"The Council estimates that a minimum of around 85,000 dwellings is the gap (unmet need) in the supply of housing in 2008... The Council acknowledges the crudeness of this estimate and also points out that there were some 830,000 vacant dwellings in Australia at the time of the 2006 Census."

There's the source of the 85,000 shortage. I've actually removed a sentence that followed because I want to highlight it separately.

But before I do, remember, this report is the basis for every single argument made by property spruikers.

So, how have they come to the conclusion that there was a shortage of 85,000 dwellings in Australia in 2008?

This is the part that left me speechless...

"The Council estimates that a minimum of around 85,000 dwellings is the gap (unmet need) in the supply of housing in 2008. This is based on the incidence of homelessness and the low level of vacancy rates in the private rental market."

The underlining is my emphasis.

There you have it. The housing market will always rise because of the 'chronic' housing shortage, a 'chronic' housing shortage being measured by the number of homeless people.

According to the report, the dwelling gap, which is the difference between the demand for housing and the supply is made up of:

Dwellings required to address homelessness - sleeping rough = 9,000

Dwellings required to address homelessness - staying with friends and relatives = 35,000

Dwellings required to house marginal residents of caravan parks = 13,000

Dwellings required to increase rental vacancy rate to 3% = 26,000

Now, the human calculators out there may think, "Hang on, that's only 83,000."

You'd be right. But in true statistician fashion, they are only capable of dealing in numbers rounded to the nearest 5,000...

Hence, there was a housing shortage of 85,000 homes in Australia in 2008.

But the report doesn't stop there. Not content with providing a suspect set of numbers for 2008, the report goes on to outline the shortage for future years.

So, based on the 85,000 starting number for 2008, this has been extrapolated to 108,000 for 2009, all the way up to 431,000 for 2028.

We're not surprised the property spruikers have never mentioned the numbers behind the gap. If they did they'd be laughed out of town.

To argue that a housing gap and therefore ever-rising property prices can be based on the number of homeless people is utter nonsense. We don't think we've ever come across such statistical foolishness.

For a start, there is a big difference between the desire for a dwelling and the demand for a four-bedroom home in the suburbs, or a two-bedroom townhouse in the inner city.

Put it this way, we haven't seen too many house auctions, but odds are first home buyers aren't facing stiff bidding competition from the local hobo.

And furthermore for the researchers to claim that the lower rental vacancy rate implies a shortage of housing is also statistical smoke and mirrors. Perhaps we could make the target vacancy rate 4% and argue there is an even bigger 'chronic' shortage in housing.

The facts are, as we suspected all along, the case for a housing shortage in non-existent. It does not exist. There is no housing shortage.

That's because it is price that is the major problem in the housing market. Prices are at unsustainable levels brought about by the manipulation of demand and supply by the various levels of government.

As soon as the manipulation ends, price discovery will lead to a collapse in the housing market.

Only then will the property spruikers realize there is not, and never has been a 'chronic' housing shortage.

Kris Sayce
for The Daily Reckoning Australia

• Traders Sell Bank Stocks Due to Goldman Sachs Surprise
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• Australian Property Market is “Recovering”
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More about that in a minute. First, the Dow went nowhere yesterday. Gold fell $14 to $939. And Newsweek magazine announced, "The Recession is Over." Newsweek hedged its bets; adding that the recovery won't be a piece of cake.

Elsewhere in the news is word that the housing bust is over. The papers are reporting the first gain in housing prices in three years - based on the latest Case-Shiller numbers. Hallelujah...right?

Hold on. There's too much statistical noise in the monthly figures. They just don't mean anything. A better measure is the annual trend. The Federal Housing Finance Agency says its index for May registered the smallest drop in 10 months...but is still headed down. (More on why it is destined to continue going down...later in the week.)

Back to the stimulus and how it works...

An article in today's International Herald Tribune tells the story of one area in Tennessee that has gotten stimulus money.

"The cash that salvaged a county," says the headline. Perry County, southwest of Nashville, must be one of those places you don't want to stop when you're driving across the country. With 25% unemployment and no significant industry, it sounds dreadful - at least from an economic point of view. It might be a nice place to live - if you don't have to work for a living.

So the county honchos figured the county needed a little stimulus. They managed to lay their hands on cash being passed out by the feds. It doesn't seem to bother anyone that the money belongs to someone else. Nor does the fact that it is now being frittered away in a bunch of make-work projects that nobody wanted to pay for even when they had some money. Nor that the stimulus-assisted businesses of Perry County now have an unfair advantage over their honest competitors in other parts of the state.

The Armstrong Pie Company, for example, used taxpayers' money to expand: "New workers [hired with stimulus money] have helped the company triple its pie production and expand its reach through central Tennessee."

A quick question: what happened to the pie companies that lost market share to Armstrong? And another: how is the economy any better off by stimulating one pie company to make more pies at the expense of other pie companies? And a final one: even if total pie consumption goes up - a larger pie! - where's the benefit?

The whole thing is a scam!

Bill Bonner
for The Daily Reckoning Australia

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House prices were up 3.3% nationally in the second quarter of the year, according to Australian Property Monitors. The group said that the weighted average median house price in the most expensive capital city suburbs was $796,559. In the slightly less expensive suburbs the weighted average median house price was $405,872.

Ouch.

Aussie stocks are up as we write, bucking the global trend from yesterday. This comes after a 7% retreat by Chinese stocks in Shanghai and lower stocks in New York. What happened in China? Well, China's benchmark CSI 300 Index was up nearly 93% for the year before yesterday's retreat. China's monetary authorities have ignited a speculative bubble and made noises about reining it in yesterday.

Bloomberg reports that Chinese stocks, "Plunged amid speculation the central bank is poised to order lenders to set aside larger reserves, Beijing-based Caijing magazine reported today on its Web site. Market News International said Chinese equities fell on speculation regulators will increase a tax on stock trading."

Yesterday we asked the question of what would make Australia's economy grow in the next twenty years. We return to that question today. The Reserve Bank has said that Aussie banks will have to move cautiously as they repair their balances sheets. This suggests growth through debt may be harder to achieve. The RBA also said that the household sector's twenty year credit binge is over (now that asset prices are returning from orbit). Again, growth through debt is looking dubious as a national survival strategy.

Let's also assume that the government cannot borrow its way to larger stimulus payments. With lower spending forecast for government, businesses, and households, you begin to wonder if Australia's economy has a home grown engine, or if it will rely on something else, or someone else beyond the borders. If domestic demand falls, that leaves housing as the only industry firing on all cylinders (for now).

Now you can try building a national economy around the housing industry. But what you get is a nation of mortgage lenders, builders, real estate agents, speculators, and bombastic television presenters. You also get a huge speculative bubble. It's been tried in America and didn't work out so well.

If not housing, then why not resources? "Over the medium term," said Glenn Stevens earlier this week, "the emergence of China (and other countries such as India) will continue, and will offer opportunities for Australia." This is not news. But what the Governor said next is newsworthy.

"If commodity prices do stay at their relatively high levels on the back of strong emerging world demand, the mineral extraction sector and all those parts of the Australian economy that service it and feel its flow-on effects, will expand. Other sectors, will, relatively, contract over time."

Hmmn.

Does this make the Aussie economy a one trick resource pony? And even if it does, so what? Investors can still profit by finding the lowest-cost mineral extractors with the best ore bodies. As Mr. Stevens noted, even the correction in commodity prices has left them at higher inflation-adjusted levels that previous corrections. Prices came off. But they didn't crash permanently. Stevens doesn't think they will, either.

"A significant structural rise in demand for energy and resources has occurred, as a result of the cumulative growth of the emerging world. This seems more likely to be a feature of the international economy for some time than to go away," he says.

That could either be very true, or famous last words before a burst Chinese credit bubble rips the legs off of Australia's economy. But we'll go along with the Governor in the assumption that China's emergence as an industrial giant is a decade's long affair. It will have its ups and downs. But the general trend will be mostly up, accounting for the structural rise in demand for energy and resources."

It sounds, generally, like pretty good news. Of course, you want to be more than just a giant quarry. Wages and profits will be higher for Aussie firms if they can figure out ways to increase productivity and add more value. Investors can capture some of these rising profits and productivity increases through dividends or share price gains.

But adding value in the resource extraction business-and capturing that value added as an investment income-is not a simple proposition. The biggest value add (with the biggest profits) comes higher up the economic food chain (somewhere between retailing and pure intellectual property, where you produce nothing physical, but still collect rents or royalties on your production).

Australia's national income could benefit from a few industries higher up in the chain of production. But the country's current position is not a terrible one to be in either. That's not to say there aren't a few risks with hitching your wagon to China's rising star.

"If we are more integrated into China's expansion," Stevens said, "will be similarly more exposed to the consequences of whatever might go wrong in that country. So our understanding of how the Chinese economy works and what risks may be accumulating there, will need continual work."

Speaking of accumulating risks, one final note today. Reuters reports that, "The U.S. Treasury sold $39 billion in five-year debt Wednesday in an auction that drew poor demand, raising worries over the cost of financing the government's burgeoning budget deficit." The big-to-cover ratio for the five-year notes was just 1.92, its lowest level in a year.

Will a U.S. bond auction fail this year? It's not likely. The Feds will rig it to avoid that. But if investors are getting choosier about financing government debt, you wonder how that may affect the ability of the Australian Office of Financial Management to fund this country's growing fiscal deficit....

Dan Denning
for The Daily Reckoning Australia

• Glenn Stevens Says Australia’s Economy Has Been Travelling Better Than Others
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• Australian Housing Market Getting Stronger Despite Fear of Inflation
• IMF Report Concludes Aussie Banks are “Very Sound”…
• Australia’s Currency and its Economy Will Benefit from China’s Stimulus Package

The depression darkens because people are not just being laid off - their jobs are disappearing. They do not get called back to work. Instead, they stay unemployed until they run out of unemployment benefits...and then the statisticians in Washington drop them off the unemployment rolls. Currently, the first batch of those people to reach the end of their benefits came this week. Last we looked, the Pennsylvania legislature was passing a law so they could continue drawing benefits for a few weeks more.

We've mentioned John Williams and his excellent service called Shadow Government Statistics. He looks at the numbers and figures out how they are twisted and tortured...and then figures out what they would be if they were treated properly. Currently, the unemployment rate nationwide officially is almost 10%. But if you computed the unemployment numbers the way they did back in the Great Depression, Williams says one in five people are out of work. In some places the figure is as high as one in four.

In other words, the unemployment numbers are already beginning to look like those of the Great Depression. But that's true of almost all the numbers. They've all got a '30s era look to them. And if you stopped water boarding them, they'd tell a similar story. Almost all the indicators are worse than any we've seen since WWII.

Unemployment, trade, defaults, foreclosures, bankruptcies, prices, manufacturing...you name it and you have to go back to the end of WWII to find similar numbers. Of course, at the end of the war, the wartime economy shut down. Millions of people who have been in uniform...or making tanks and airplanes...were suddenly out of work. Economists thought the economy would go right back into the Great Depression. Instead, it boomed.

Those soldiers and their families had savings. They had pent up demand - they hadn't bought a new car in 10 years...they were young...they got married...they had children...they needed baby cribs and houses. We remember going to look at one of the first major suburban developments as a child - Harundale - in Maryland, built by the Levitt Company.

It was a horrible place, but you could buy a house for peanuts...on credit. And it set the pace for the suburban consumer credit expansion of the next half a century.

But what was normal for so many years is not normal any more. Now, consumers are paying off debt faster than any time since 1952. The government, however, is making up for them. Goldman may no longer be able to push more credit onto the public; but it can push one heckuva lot of debt onto the public sector. Wall Street firms helped households ruin themselves in the Bubble of 2003-2007. Now they're doing the same for the government, helping the feds raise money on a scale never seen before in human history.

As we said...no wonder they're making money. Too bad.

Bill Bonner
for The Daily Reckoning Australia

• If Americans Do Not Return to Work, There Is No Recovery
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• We Expect No Recovery from the Economy
• Housing and Unemployment Are Weaknesses in the U.S. Economy
• Consumer Prices are Rising at About 10% Per Year

This denial of reality should be interesting to watch. When a credit bubble deflates and an economy breaks its addiction to reckless debt, the sensible thing to do (since you're repairing your balance sheet) is dial things back a bit. Save. Cut back on the gadgets. Eat more staples. Wear a sack cloth.

But if you still believe that you can get something for nothing-well then yes-you'd continue to borrow and spend like a madman.

Speaking of borrowing, we'll have an idea tomorrow of whether borrowing costs are headed up, down, or nowhere. The Reserve Bank of Australia meets to determine the price of money (in whatever mysterious way it manages to do this).

It will have to consider another piece of data from last week: a 12.5% seasonally adjusted decline in building approval for new homes. This is a provocative little nugget, isn't it? That's a steep month-over-month drop. Year-over-year, total approvals for new homes fell 22.4%. But wait...there's more!

Approvals for multi-unit "other" dwellings fell 43.6% month-over-month and 57.5% year-over year. We assume this means multi-room apartments and not houses. But either way, that kind of one-month decline looks an awful lot like hitting a brick wall. The Australian Bureau of Statistics says that's the lowest level of approvals since 1987.

What could it mean? There may be a perfectly reasonable explanation for such an ugly number. One that comes to mind immediately is that developers think there is plenty of existing inventory already (much of it unoccupied). With a large supply on hand, why build more?

Another reason is that developers don't expect prices to rise higher. Why add more new housing stock if you conclude that A.) the housing market is adequately supplied (not short, as is so often claimed) and B) the demand for new mortgages (new housing finance) is also going to fall off a cliff when the first home buyer's grant expires or interest rates begin rising (whichever comes first).

Dan Denning
for The Daily Reckoning Australia

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• Job Losses From Private-sector Rose Since Beginning of Recession
• Traders Sell Bank Stocks Due to Goldman Sachs Surprise

Will the Amero replace the dollar? Not at all...this myth has already been debunked online. If there were a new currency we also wouldn't expect to see it any time soon, that's our guess. We're in a depression. Maybe it will become a Great Depression...or a Greater Depression, we don't know. But it is a time of credit contraction...not credit expansion.

For the moment, prices are falling. The dollar is safe...at least, for now.

We paid a visit to France over the weekend. No one knows how France stays in business. Everything is very expensive and very difficult. Half the population struggles to earn a living. The other half struggle to stop them. But more about that later....

What caught our eye, walking down the street near the Communist Party headquarters, was a clothing shop. A few blocks away, you will pay $100 for a pair of jeans. But in this sidewalk shop, you can get a pair for $10. Shirts for $5. Jackets for $8.

The store is owned and run by what appears to be a Chinese family. They probably skirt French employment law by keeping the entire operation in the family. Then, rather than an expensive store, they have a cheap storefront in a bad part of town and put everything out on the wide sidewalk. Even in bad weather, they stretch out a tarpaulin over the clothes racks.

A $3 shirt? A $10 pair of jeans? That's deflation. A few months ago, these same clothes may have had designer brands on them - alligators or polo players, perhaps. But upscale sales are falling. So the factories take off the brands and dump their excess production onto the low-rent market.

We don't know that for a fact...we're just putting two and two together.

Excess capacity was built with excess credit. That's what happens in an expansion. Entrepreneurs borrow to increase production so they can sell more products to credit-addled consumers. Then, the excess capacity dooms them. They put out too many goods and too many services. When demand falls - along with incomes and housing - prices fall too.

Yesterday, the dollar held steady. The yield on the 10-year T-bond fell to 3.69% after reaching up toward 4% a few days ago. The rise in bond yields (with falling bond prices) was probably the most interesting story in the financial world...until they stopped rising.

What's going on?

As we explained, there is no real economic recovery taking place. In fact, there is a lot more risk and mayhem on the horizon.

And with no real economic recovery, don't expect a real bull market on Wall Street. Or real pressure on bond yields. (Of course...there's much more to the story...so stay tuned.)

In the meantime, yesterday, the Dow dropped 200 points. It looks to us as though the rally is coming to an end. If you're invested in U.S. stocks now, sell them. They could go higher...but it's not worth the downside risk. In the meantime, check out the 'millionaire's market'. It may be your best bet for turning a profit in this environment.

Some things are obvious and predictable. Other things are not. And, of course, we always have to remember that we don't know what we are talking about. As colleague Alex Green's delightful new book reminds us, "the only certainty is surprise." More later...

What is more or less predictable is that a severe depression is developing. Our iron law puts it this way: the force of a correction is equal and opposite to the deception that preceded it. The Bubble Epoque was extraordinary in practically every way - with illusions, frauds and absurdities galore. Ergo, so must be the Bust Epoque that follows.

From the housing sector comes news that even though houses are much cheaper they are not necessarily much more affordable. While prices are falling so are incomes and employment. Mortgage lenders, meanwhile, learned that they needed to be more careful about whom they lent money.

In 2007, the banks were so loose their arms practically fell off. If they had been young girls, you would have found short poems about them in the boys' toilets. They weren't prudent lenders; they were promiscuous ones. But now house prices are falling and lenders say 'no' to everyone. But unfortunately, that won't undo the mistakes of the past - the mistakes that are deciding the future of the US economy. The lax lending standards caused the first wave of loan defaults that rocked the banks to their core...and now the second wave is headed straight for the United States.

So the poor lumpen are trapped between falling incomes and rising lending standards; they can't buy a house even at a much lower price.

The retailers are trapped too. They leased huge spaces to sell their wares; now they have no one to sell their wares to.

Sales go down; so do earnings. Bloomberg reports that business executives see what is coming. They look at the figures and see their businesses trapped between high output capacity and low pricing power:

"Insiders Exit Shares at the Fastest Pace in Two Years," begins the headline.

"Executives are taking advantage of the biggest stock-market rally in 71 years to sell their shares at the fastest pace since credit markets started to seize up two years ago.

"Insiders of Standard & Poor's 500 Index companies were net sellers for 14 straight weeks as the gauge rose 36 percent, data compiled by InsiderScore.com show.

"Sales by CEOs, directors and senior officers have accelerated to the highest level since June 2007, two months before credit markets froze, as the S&P 500 rebounded from its 12-year low in March. The increase is making investors more skittish because executives presumably have the best information about their companies' prospects."

Even governments are trapped. Yesterday, Nicolas Sarkozy told the French that he wasn't going to follow the 'austerity policies' urged on him by the European Central Bank. "Austerity policies never work," he said.

The French deficit is more than twice the levels permitted by the European Union's economic guidelines. But at 7% of GDP, it is still barely half America's government deficit.

And over on America's left coast, the government of Arnold Schwarzenegger is faced with the same crisis - only worse. The New York Times tells us that states, led by California, are putting government employees on forced furloughs, releasing prisoners early, closing parks and reducing education budgets. They need to watch out; citizens might notice that they never needed to spend so much money in the first place.

Speaking of prisons, for example, the states could save a fortune simply by getting rid of the jailbirds who never really did anyone wrong. By that, we mean the people who didn't harm anyone but themselves...and arguably, not even themselves. There are hundreds of thousands of people in prison for drug crimes, for example. Let them pay a fine and turn them loose.

(If we were running things, we'd legalize drugs and make alcohol and cigarettes compulsory. TV, rap music and Barbra Streisand performances, on the other hand, would be outlawed.)

"France is rotten," said a dinner guest on Saturday night, recalling de Gaulle's famous warning that Vietnam was a "rotten country"...and that Americans should stay out.

"I'm fed up. You can't do anything in this country without either getting permission or getting a fine. You can't drive fast...even though the highways are made for much faster traffic. You can't smoke. You can't start a business...or sell one...or hire anyone. The way these employment laws work it's safer to murder a bad employee than fire him.

"Someone is always telling me what to do...and it wasn't like that a few years ago. I'm old enough to remember what it was like in the '60s and '70s. France was still a free country back then. You could do pretty much what you liked. You could ride down the road without putting on a seat belt. You could smoke in bars. If you didn't like your job you could tell your boss to go to hell. Then, you'd just look in the paper...there were always hundreds of jobs. People changed jobs. If one didn't work out...they tried a different one. Now, if they don't like their job they go to court and the employer is really in trouble. The whole process is rotten.

"What I'm really surprised about is the way the French have gone along with all this bossing... They're sheep."

"Wait a minute," another guest challenged her. "France is still a great place to live. The food is good. The weather is usually pretty good. The health service works. The trains run on time...at least, when the workers aren't on strike. It's pretty to look at. I don't know how much you've traveled, but compared to the places I've seen, France is way ahead. Besides, if you don't like it so much, why don't you just leave? Find some other country you like better..."

"Ha...I'm too old now...and besides...they're all rotten."

Bill Bonner
for The Daily Reckoning Australia

• French Model of Economy Allows Meddling from the State
• Bastille Day: The French Revolution Didn’t Change Much
• The Kitchen is the Place to Be
• The French are Feeling Pretty Smug
• A Nightclub in the Middle of Rural France

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

Yet one still has to worry about the United States itself, despite the optimism being expressed by the Federal Reserve Board. The two obvious weaknesses of the U.S. economy are housing and unemployment. In April, new residential building in the U.S. fell to its lowest level in fifty years, dropping to an adjusted annual rate of construction of 455,000 units. Housing starts dropped by 12.8 per cent, bringing their fall for the year to 54 per cent. At the peak of the housing boom, in January 2008, housing starts reached 2.27 million; the fall from the peak is now 80 per cent, and there is no immediate sign of a recovery.

Lex, in The Financial Times, makes the rather pessimistic comment that “the U.S. housing market is still there, stubbornly refusing to improve… The trend has defeated every effort to call a bottom in the market”.

There is still a large inventory of houses available for sale, overhanging the U.S. housing market. According to the National Association of Realtors, this inventory stands at 3.7 million, equivalent to 10 months supply. On top of that there is a shadow inventory of homes which have been foreclosed by banks, but not yet put up for sale. Foreclosures themselves are still rising, by about a third, year on year. That rise is expected to continue, if only because of the rise in unemployment.

Of course, the unemployment figures themselves are lagging indicators. They will continue to rise when the worst of the financial recession is over. In the last eighteen months, U.S. unemployment has virtually doubled; it seems certain that U.S. unemployment will reach 10 per cent in the second half of 2009, and probable that the increase will continue in 2010.

These two indicators are worrying, because they interact. If unemployment continues to rise, still more houses will be repossessed, and will eventually come onto the market. House prices will continue to be weak, as banks seek to recover their loans, whether directly owned or expressed through derivatives. The banking industry will continue to depend heavily on Government injections into the money market. The sickness of the money market caused by toxic debt will remain a problem. It was the impact of the housing collapse on the banking market that created the 2009 recession, the worst recession in 50 years. Until the housing market stabilises, the money market cannot be better than convalescent; until the money market recovers, unemployment in the U.S. is likely to go on rising.

In the history of recessions, their depth and duration has been broadly proportionate to the initial impact of the shock. In the United States, the aftershocks of the Great Depression continued until 1938. The economy was finally lifted out of depression by British orders for armaments. We may well have reached the point at which the decline is decelerating, but the trends in U.S. housing and unemployment are still unfavourable. It is likely that there will be further periods of bad news, as well as rallies. We should not exaggerate the scale of recovery.

William Rees-Mogg
for The Daily Reckoning Australia

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