Yes, dear reader, even our heroine, Angela Merkel, is joining the fools' parade. In a front-page feature in yesterday's International Herald Tribune we learn that Ms. Merkel is bringing Germany in line with the rest of the world - by increasing the public deficit to over 6% of GDP.

"Germany chooses growth over paying debt," says the misleading headline.

But 6% is only half the US level...and the UK is nearing 15%!

The raw news: the Dow fell 93 points yesterday. Gold held above $1,100. There's no sign of panic. But we keep our Crash Alert flag flying anyway; you never know.

We're in Rome...actually in the airport...on our way back to London. Alitalia offered the best deal to Buenos Aires. But the plane was a disappointment. The food was good; the hostesses were pretty; but the seats in business class didn't fully recline. After the first 10 hours, we were very uncomfortable. And pity the poor folks in economy!

But if you want to be an "international man," as our friend Doug Casey termed it, you have put up with some inconvenience. Why would you want to be an "international man?" As another old friend, Marc Faber, observes, it pays to travel. You get a broader perspective. And you realize that many things your compatriots take for granted others take for absurd. "The more you look, the more you see," is our dictum.

One thing Americans take for granted is that they will always be the richest, most successful people on earth. They think that because that is what they have always known. The US economy became the biggest in the world before 1900. Americans had just what it took to become the richest people on the planet. They worked hard. They saved their money. They had little government interference. They had the industrial revolution at their backs...and nothing in their way. And they had a dollar that was 'as good as gold.' By the time the baby boomers were born the US had such a big lead over the rest of the world, it seemed like nothing could stop it. Free enterprise guaranteed new innovations and new wealth. Democracy guaranteed a political system that would adapt to the needs of the evolving economy.

But nothing lasts forever. As it matured, the US economy and its political system became more and more rigid and more and more costly, with handouts and bailouts...at every level. Large companies are protected. Millions of people are encouraged not to work. The whole financial industry is dipped in honey. And the whole population is urged not to save, but to spend. Why bother to save for retirement; there's Social Security. Why bother to save for health care emergencies; there's the government's new overhaul of the medical system! Why bother to save at all; the government has fixed short-term rates so low you get nothing for your trouble.

On our travels what we notice is that there are a lot of smart people in the world. And they're all sweating, striving, and angling to get ahead. You never know who will win the race, but you can be sure that no one will stay in the lead forever.

"US Wages Out of Balance," says The New York Times. It is pointing out the obvious. Americans are paid too much, compared to other people in the world who work just as hard and who now - thanks largely to the feds - have as much or more capital than we do.

Wages in the US will come down - probably thanks to unemployment and inflation. So will US living standards compared to the rest of the world.

Meanwhile...back to Angela...

Generations of German central bankers learned their lesson. They saw what happened when hyperinflation ran wild in the '20s. The middle class was wiped out in a matter of days. People lost faith, not only in the Deutsche Mark, but in Germany itself...and in all the old values. The next thing they knew, the Chancellor was wearing a silly uniform and they were on the road to Hell.

More recently, the last generation of German central bankers worried about the euro. They had no doubt about themselves. They had the backbone to protect their new currency. But what about the Italians? And the Greeks? And the Irish?

Well, they can fret no more. Now, the German deficit is higher than the Italian deficit.

Why would they do such a thing? They have the usual poppycock explanations - countercyclical spending, the need to maintain social services as tax revenues fall, the need to bailout the East, (see below) etc. But the real reason is that the old German economists are dead. One of the last of them was our colleague Kurt Richebächer.

Every time we saw him, Kurt would complain about American and English economists.

"Ya...you Anglo-Saxon economists are ruining the world," he would say. Kurt had no truck with Keynesianism. Or monetarism. Or any other of the fads in economics. Besides, he had lived through Germany's hyperinflation, the rise of National Socialism, WWII, partition, and finally, reunion. He knew that there were no free lunches...no easy fixes...and no panaceas. He knew too that people who promised miracles were dangerous frauds. Wealth is created by work...saving...innovation...investment...and perseverance. There are no miracles. No short cuts.

While wealth is created by work and saving, it is destroyed by consumption and debt. When you borrow money, you have to pay it back. Then, you must draw down your wealth...reduce your living standard...and cut into the capital you laid away in years past. You can try to squirm and dodge...but you just make the situation worse.

Kurt was right.

But now Kurt is dead. A new generation of economists has taken over. Born after the war, they know hard times only from movies and history books. They haven't forgotten the old truths; they never learned them. Instead, they probably did their training at Harvard or Chicago...and studied nonsense...such as the Efficient Market Hypothesis and Modern Portfolio Theory.

They think the key to prosperity is spending. Consumers spend until they can't go on. Then it's up to the government. That's why the Germans are running such a high deficit. The think they need to keep up spending - at all costs - in order to boost the economy. As Kurt used to point out, it makes no sense theoretically...and there's no evidence that it works in practice either. Every time governments have intervened with large dollops of countercyclical spending they have made a mess of things...either by stimulating the private sector to further acts of reckless insolvency...or by blocking the process of correction.

It's all claptrap. Angela, you should be ashamed of yourself.

Bill Bonner
for The Daily Reckoning Australia

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But wait...what's this? The average maturity of that debt has come down from more than 5 years to only 4. And according to the Office of management and Budget, if the US continues on its present course, net interest will rise to 5% of GDP in 2019 and 10% in 2034.

And that assumes there is no big increase in interest rates...and that the economy recovers as planned. If either of those things fails to happen, the situation will degrade fast.

Imagine if the government were forced to refinance debt at double-digit interest rates - as it was in the late '70s. Net interest could go to 5% of GDP within months.

We're in a depression, not a recession. Depressions take longer to sort out. But they are also far more treacherous. Because there are always periods when things seem to be going "back to normal," only to go back down again as soon as investors turn bullish.

Richard Koo, author of The Balance Sheet Recovery, recalls how it was during Japan's long, dark passage:

"We had these false starts... The economy would begin to improve and then we'd say 'oh my god, the budget deficit is too large.' Then we'd cut fiscal stimulus and collapse again. We went through this zigzag for 15 years."

Koo understands what is going on, more or less. Companies and households are paying off debt. He and Paul Krugman believe the feds have to continue pumping money into the system or they're going to have a "lost decade," just like the Japanese.

You have to keep the stimulus money flowing "until the private sector de-leveraging is over," he says.

By our calculations, it will take 5-10 years for the private sector to de-leverage. By that time, the feds will have added trillions in debt to public finances. Since they can't finance that much from private domestic savings, and since foreigners will be wary about lending that much even if they had it, the Fed itself will have to pony up the money. This will put the dollar in further danger...along with the entire global financial system.

Koo may be right - as far as his thinking takes him. He should think a little further. The problem is debt. Too much debt in the private sector caused bear markets and a bank crisis. Too much debt in the public sector will cause big problems too - a default...and hyperinflation. Worse than a depression.

Bill Bonner
for The Daily Reckoning Australia

• U.S. Government Must Roll Over $3.4 Trillion in Debt Over Next Four Years
• Government Debt Bubble is What Directly Precedes Inflation
• What’s the Best Way to Get Through a Debt Crisis?
• Household Debt Represents Spending Taken From the Future
• In Europe, Banks Borrow Money and Lend it Back to the Government

Here at The Daily Reckoning we may hate the devil and renounce all his works...but we're betting on him anyway...

Let's begin with the headlines:

"Financials Slam Wall Street," says a headline. The Dow fell 92 points. Makes us think the financials didn't slam it very hard.

Gold rose. Oil rose. And the dollar sank below $1.50 per euro...another milestone.

As we reported yesterday, investors think the recovery is for real...and that it will boost up prices of commodities and stocks. The dollar, on the other hand, is chopped liver.

But we have a feeling that the devil is on the side of the dollar. Let's us explain.

"How Wall Street Will Kill the Recovery," is a headline at BusinessWeek.

Finally, everyone is catching on to how it works. The big banks take the feds' money...then they speculate with it ...or lend it back to the Fed for an easy 400 basis points of gain.

At Seeking Alpha, they're talking about "the return of Japan's zombie finance." Over at The Wall Street Journal they've talking about America's own "Zombie banks."

But these monsters are only reacting to the jolt of juice given them by the Dr. Frankensteins at the Fed and the Treasury. It has become very unprofitable to hold cash; the feds are creating more of it by the boatload. You get a minimal rate of return on cash...while other assets go up. And the feds can't stop...or change course...not without sinking the whole economy. They may talk about an 'exit strategy.' But the exits are blocked. Remember cash is created when the feds "monetize the debt" by buying US Treasury bonds. In order to exit...that is, in order to reduce the monetary base...they'd have to sell those bonds back into the open market.

Are you kidding, dear reader? After being the single largest buyer on the planet? Imagine what will happen to the bond market when investors realize that the Fed is selling! It's not going to happen. Instead, that $1 trillion increase in the monetary base is more or less permanent...and it's eventually going to turn up as inflation.

The feds have no idea what is going on. They consistently misunderestimate the devil...the market...and the economy. And they consistently misoverestimate themselves.

In short, the old timers were right. To them, an economy was a natural thing...like an eco-system...or a language. It followed natural rules...rules that no man could change. It was like a living organism. It needed to breathe in and breathe out. And like all things under heaven, it was subject to moral laws. Do the wrong thing and you (an economy...as well as an individual) will pay the price. You don't get what you want from markets...you get what you deserve.

This seemed intuitively correct to generations of economists. Not only that, it was proved correct time and time again. Each time people borrowed too much and spent too much money, they came a cropper.

You may ask: "How much is too much?" According to the record, compiled and analyzed by professors Reinhart and Rogoff, it's impossible to say exactly. One nation can support public debt of 200% of its GDP (Japan comes to mind)...another cracks up at 50% (think of Argentina). A man like Donald Trump can carry millions in debt...another goes broke if you lend him 20 bucks.

(At one point Donald Trump was the poorest man in the world. His net worth was negative by 10s of millions (we don't recall the figure). All over the world, hundreds of millions of people could have said: 'I'm richer than Donald Trump.' Even if you didn't have a dime, you were richer than The Donald.)

So, how much is too much debt? It depends on what you use the money for...how much you have in assets...whether your earnings are shrinking or growing...and a number of other questions. But while the answers aren't simple, the questions should still be asked: If you run up a debt, how are you going to pay it back? What will happen if you don't pay it back?

A professor at the University of Basel, Peter Bernholz, thinks he has the answer. He studied instances of hyperinflation. He believes that you get hyperinflation any time the government spends 166% or more of what it receives in revenues. This should set off alarm bells. The US budget is now about 170% of tax receipts.

The feds can't repay the record amounts they're borrowing - not without a major political crisis. They'd have to cut spending and raise taxes so dramatically it would cause a backlash. The parasites would revolt. It would probably unseat the ruling party and break the repayment plan. Generally, people prefer inflation...or default...to actually paying their public debts.

One way or another, however, the devil debt will have his due. Somebody is going to pay - if not the borrower...then surely the lender. There's a bullet out there. Someone has to take it.

But who believes it? The old economists are dead. John Maynard Keynes denied that debt mattered very much. Then, his successors forgot that it mattered. Dick Cheney told his party to stop worrying about it. And now a whole plethora of modern economists and politicians believe that the problem with today's economy is that there is not enough of it. Debt that is. They think the government should borrow and spend even more. To them, the whole secret to a healthy economy is how much money people spend. Yes, it's absurd, but that doesn't make it unpopular. People like spending money. And they welcome economists who tell them that they're doing the right thing.

Since Keynes, economists pretend the devil doesn't exist. They believe they are not part of nature...controlled by natural laws. Instead, they want to take control of nature. And the only way they can get a grip on economies is to break the boom-bust business cycle. And you can't do that unless you pretend that debt doesn't matter.

The trouble with real markets is that they are always subject to human emotions and human calculations. It is a quality that George Soros describes as "reflexivity." Markets act differently, depending on what people believe. And when the authorities try to turn their knobs and yank on their levers, it changes both what people believe and what they do - but not necessarily in the way the feds want.

It is much easier to manipulate speculative markets than it is to manipulate the real economy. Want to drive up prices? Just give speculators some free money to play with! Guarantee their debts! Bail them out of their stupid positions! That's what the feds have done. And that's why the banks - the recipients and conduits for the free money - are making profits. Goldman allocated $527,000, per employee, in compensation for the first 9 months of this year. An increase of 46% over last year.

Gold, oil, copper, stocks - all are in government-induced speculative booms. But the underlying economy is harder to move. In order to get consumers to spend, the feds have to put money into their hands...and raise prices so consumers will want to get rid of it, rather than hoard it. But that is proving very hard to do.

Why? Because of the debt. Consumers have to pay down their debt. They have to cut back. They have to spend less. So, the economy shrinks.

And now The Wall Street Journal is talking about another downdraft in the housing market. It could get "even uglier" it says. Why? The mortgage debt that still have to be reset and rescheduled. Apartment rents are falling as unsold units are put up for rent.

Sales at luxury stores go down as consumers work their way back down the price chain. Why? They have to spend less as they pay off their debts.

Yes, you can ignore debt...until you go broke!

Bill Bonner
for The Daily Reckoning Australia

• Investment Banks Making Money Thanks to US Government Bailouts
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"We are sinking in a sea of debt," he admitted. And on the very day when France's president, Nicolas Sarkozy, said he would not raise taxes, Osborne said that he would not lower them. In order to lighten Britain's debt, he'd leave Labor's 50% maximum tax rate right where it is.

Voters don't like hearing about debt. Politicians don't like talking about it. And economists don't want to think about it. And in a kind of collective suicide pact, they have all agreed not to worry about it. But debt is at the center of the world's financial troubles.

Paying off debt is like dying. You try to put it off as long as you can. But nobody runs an open tab forever.

This week brought news that Maine-based luxury yacht maker Hinckley, which has been building boats since 1928, is sinking. The problem is neither technical nor operational. It is philosophical. No one complains about the quality of the boats. Or even the prices (if you have to ask, you can't afford one). The company sailed along nicely until 1997. Then, the private equity hotshots from Boston took the helm. The old Hinckleys who ran the shop looked upon debt as though they were looking at a bottle of whiskey. A drink now and then did no harm. But watch out. Too much will sink you. In the 70 years they ran the place, they accumulated only $1 million of debt. But the new owners were dipsomaniacs; they multiplied Hinckley's debt 20 to 40 times. (Exact figures are not available.)

For much of history, failing to repay debt was regarded as not merely a breach of contract, but a crime. People who failed to repay their debts in timely fashion were thought to have stolen from their lenders; they were put in prison. In the Middle Ages even a dead debtor's children could be sent to prison.

Now, bankruptcy laws allow individuals and businesses to go to rehab. Then, they can stiff creditors again. Neither sin nor crime, debt is now just a cost of doing business.

But few creditors are as forgiving - or perhaps as forgetful - as those who lend to governments. That is the conclusion of a new book by Carmen Reinhart and Kenneth Rogoff, This Time It's Different. The two professors document the history of eight centuries of "financial folly." What we learn from it is what we already knew - that borrowers are often perfidious, crises are usually insidious, and bankers are morons.

Just five years ago, Ben Bernanke looked out on the calm seas of the Bubble Era. "The Great Moderation," he called it. Bernanke took the credit. It was due to "improved macro-economic policies," he said. In retrospect, he probably should have said it was just luck and left it at that. His macro-economic policies made things worse, encouraging all sectors of the economy to borrow. We know what this did to Hinckley. Riding low in the water, with too much debt heaped on its deck, the yacht maker struggles to stay afloat.

But what's new, ask Reinhart and Rogoff? Always and everywhere, debt leads to trouble. Too much debt caused France to default on its sovereign debt eight times. Spain defaulted six times before 1800 and then another seven times later.

Latin America, as the authors point out, would have been safer for bankers if the printing press had never made its way across the Atlantic. Between hyperinflation, defaults and banking debacles - over two centuries - the banana republics scammed banks out of billions. In the '80s, Nicholas Brady tried to rescue New York bankers with his US- backed "Brady bonds." Readers of these back page columns can guess what happened next. Within a few years, seven of the 17 countries that had undertaken a Brady-type restructuring had as much or more debt than they had before. By 2003, four members of the Brady bunch had once again defaulted and by 2008 Ecuador had defaulted twice.

Even non-existent countries go broke. In 1822, "General Sir" Gregor MacGregor issued bonds from a fictitious country he called Poyais, whose capital city, Saint Joseph, was described by the offering prospectus as having "broad boulevards, colonnaded buildings and a splendid domed cathedral." The bonds sold at lower yields than those of Chile. But it didn't matter whether the country was real or imagined, all of them defaulted.

As for the present slump, the authors offer no predictions, but some guidelines. In the run-of-the-mill crisis, real housing prices generally go down 36% over a six-year period. GDP, in real terms, per capita typically goes down 9.3% while unemployment rates go up for five years, with a 'normal' increase of about 7 percentage points. But the closest parallel to the present circumstance, which they call 'the Great Contraction,' is the Great Depression of the 1930s - which was much worse. Unemployment in Germany and Denmark rose over 30%. Building activity fell 82% in the United States. Chile saw a 90% collapse in its exports.

Tax revenues fall in an economic slump. Government expenses increase (especially when the authorities are ready to do 'whatever it takes' to stir a recovery). Typically, say Reinhart and Rogoff, public debt increases 86% over a three-year period following a financial calamity. Then come more catastrophes, caused by too much debt in the public sector. Both Britain and America are now running deficits of more than 10% of GDP. Neither has a creditable plan for reducing debt or deficits. So stay tuned. Much more trouble lies ahead.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Fed Will “Monetize the Debt”
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• US Dollar is Getting Trashed
• Cash is Created When the Feds “Monetize the Debt” by Buying US Treasury Bonds

We're not sure if there are still places available. It's free, but you'll have to RSVP. You can do so here. It's a great chance to hear two independent thinkers offer an alternative explanation for what's going on, an alternative to the rosy everything's fine clap trap in the mainstream.

If you're not in Melbourne or can't make it, don't worry. We're going to take up some of Dr. Hudson's main contentions over the next month and "unpack them" as the saying goes. Among other things, he's arguing that we are moving to a "Neo-Feudal" world where the landlords and the bankers are again in charge of the economy (and the world).

Their strategy is to get the rest of the country into as much debt as possible. Whether this is so they can increase their claims on financial wealth (rents, interest payments, and capital gains on asset prices) or whether it's a political program to subjugate the population...that's one of the questions we were going to ask.

We were also going to ask if the "de-industrialisation" of advanced Western economies that Dr. Hudson talks about is a reversible process. Can Europe and America ever compete with China and Asia in manufactured goods? And if they can only do so in high-end goods (capital goods, technology, aerospace, IT etc.) what does that mean for the structure of employment in Western economies and corporate earnings.

Dr. Hudson, it seems to us, is right to point out that there is a kind of "Financial Oligarchy" that seems to be benefitting the most from the financialisation of the economy. But everyone else - those betting on higher share and house prices to pay for retirement (and pay off huge debts) - may not fare so well. What should you do? What can you do? More on this in future reckonings.

For today, we'll go to the mailbag and see what your fellow readers have to say.

Dear Dan,

Dear Dan

Hi,

From another Ralph...

Hi

Ralph F.
Little Hartley, NSW Australia

Dan Denning
for The Daily Reckoning Australia

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"The future will be a total disaster, with a collapse of our capitalistic system as we know it today, wars, massive government debt defaults and the impoverishment of large segments of Western society," he writes.

"We have a money-printer at the Fed," he continues, "which guarantees runaway inflation, wholesale debasement of the dollar, and a major lowering of living standards for most Americans and many Europeans as well.

"Meanwhile, Paul Volcker says that China's rise merely 'highlights the relative decline of the US.'"

So there you have it: China on the way up, America on the way down.

That's the drama that we're watching every day, here at The Daily Reckoning. In our view, the peak of US wealth and power probably came during the period between the fall of the Berlin Wall and the fall of Lehman Bros. But there are probably a lot more shoes to drop before people are fully aware of what is going on.

The way we see it, almost the entire 20th century was a mistake...a dead end.

Europeans were clearly on top of the world when the century began. Then, after WWI the Europeans in America took the lead role. But WWI shook their faith in their evolving political order. Not long after, the German hyperinflation and the Great Depression shook their faith in their economic and financial order. This left a huge vacuum, which was soon filled by ruthless adventurers and ideological schemers. Much of the rest of the century...from '39 to '89...was spent in hot wars and cold wars against these Bolsheviks, Fascists, Stalinists and Maoists.

In the end, the more reasonable and consensual societies of the West won the battle. But they, too, were transformed by 50 years of war and nearly a century of bad ideas.

"Whoever fights monsters should see to it that in the process he does not become a monster. When you look into the abyss, the abyss also looks into you," Nietzsche warned.

Looking into the abyss created by Mussolini, Hitler, Tojo, Pol Pot, and the rest, Western societies decided both to fight them...and to join them. Tax rates soared. Regulations multiplied. University professors taught socialism, Freudianism, modernism, cubism, feminism, racism...and every other 'ism' they could think of. Parents spent good money to spend their children to universities that turned them into mush-heads.

And - perhaps most ominous - in the United States of America, the military grew into a greedy, grasping goliath...the very thing Eisenhower had warned against.

Then, there were counter-trends in the '80s...led by Margaret Thatcher in England and Ronald Reagan in the United States. But these were mostly frauds. Top marginal tax rates were rolled back. And there were some cuts in regulatory procedures. But government spending tended to go up anyway. Worse, Ronald Reagan mistook the Soviet Union for a genuine threat and increased military spending even further to combat it.

And now, the United States staggers under the weight of its eternal wars...its imperial illusions...and its everlasting efforts to provide bread and circuses. If it kept its books like a private enterprise, it would be broke. If it were a public corporation, it would be de-listed.

Still, it spends and spends...and there is no stopping the spending. Trillions are spent on wars in Iraq and Afghanistan, for no apparent reason. But who complains? Too much money is at stake. There are too many lobbyists for too many industries and too many special interests involved. Military spending - even in a time when America faces no substantial challengers - cannot be rolled back. Neither can social spending.

Marc Faber is right. There too, there are too many people with too many dogs in this fight. Both military and social spending will continue to expand until the empire is ruined.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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Although I have great sympathy for the deflation crowd, given the reckless attitude of the central bankers and their ability to create debt-based money, I do not believe deflation (contraction in the supply of money and total debt) is very likely.

For sure, in this post-bubble environment, American consumer debt continues to contract, but this is being more than offset by the expansion in federal debt. Over the past year alone, federal debt in America has surged from US$9.645 trillion to US$11.813 trillion. In other words, during the past twelve months, American federal debt has risen by a shocking 24.47% and it now stands at 83.52% of GDP! Now, given the ability of the American establishment to essentially create dollars out of thin air, I have no doubt in my mind that it be able to inflate the economy. However, this will come at a huge cost and the victim will be the American currency.

In fact, the recent weakness in the US dollar is a sign that central-bank sponsored inflation has started to dominate the private-sector debt contraction in the West. Furthermore, over the past few weeks, various governments have issued US dollar-denominated debt and this suggests that the carry-trade is back in vogue. In a startling move, Germany recently announced that it plans to borrow money in US dollars!

Now, given the ongoing federal debt inflation, debasement of paper currencies, sky-high budget deficits and competitive currency devaluations, the macro-economic environment has never been better for precious metals. Yet, both gold and silver continue to frustrate the bulls by staying below the record-highs recorded in spring 2008.

So, what is going on here? Have we already seen the end of the precious metals bull-market or are we about to witness an explosive rally? Before I attempt to answer this question, I want to make it clear that even though gold failed to better its all-time high during last autumn's panic, it was the only asset, (apart from US Treasuries) which stayed relatively firm. And looking at the various markets today, gold is the only asset that is flirting with its all-time high. So, whether you like it or not, gold deserves some credit for fulfilling its role as a safe haven.

Now, unlike some of the die-hard gold bugs, I don't believe that gold is the ultimate asset to own at all times. Without a doubt, there have been times in history when gold has proven to be a lousy investment. For instance, between 1980 and 2001, the nominal price of the yellow metal fell by an astonishing 70%. This horrible price action spawned an entire generation who grew up hating gold and up until a few years ago, the vast majority considered gold a barbaric relic.

However, during other periods in history, when macro-economic uncertainty was high and inflationary expectations were running out of control, gold turned out to be a fantastic asset to own.

If my take on the macro-economic situation is valid, then we are in such a period now and gold must form a part of every investment portfolio.

You may remember that over the past year, central banks have injected trillions of dollars into the banking system and it is only a matter of time before inflationary expectations start spiraling out of control. Up until now, this 'stimulus' money hasn't permeated through the economy in the West but once money velocity picks up, prices will start rising and the investment community will become very concerned about inflation. When the deflation scare abates and people start protecting the purchasing power of their savings, capital will start to flow towards precious metals.

Long-term clients and subscribers will recall that about two years ago, I highlighted gold's tendency to rocket higher every other year. Figure 1 captures this trend perfectly and you can see that since the outset, gold's bull-market has been punctuated by lengthy consolidations and the yellow metal has surged to a new high every alternate year.

So, if gold remains in a bull-market and its trend consistency is intact, its price should surge over the following months. Conversely, if the price of gold fails to climb above its all-time high before year-end, it should start to ring alarm bells as this would open up the possibility that the bull-market may be over. Remember, certainty does not exist in the investment world and savvy investors should remain open to all outcomes.

Now, given the uncertainty in the world today and the ticking inflationary time-bomb, my view is that gold will soon embark on its north-bound journey. So, I suggest that investors hold on to gold and the related mining companies which will probably continue to perform well until next spring.

As far as silver is concerned, it has always been a high-beta play on the direction of gold. If the next up leg in gold's bull-market materialises, the price of silver will also head towards the heavens. Accordingly, investors may also want to allocate a portion of their investment portfolio to silver bullion and silver producing companies.

Regards,

Puru Saxena
for The Daily Reckoning Australia

• Gold Flourishes but Silver is the Real Precious Metal Story of Late
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• Gold and Silver!
• A Word About the Dollar’s Decline from Our Intrepid Correspondent, Byron King:

"The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I'd give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s.

"The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products...beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25%. (That's not a misprint!)... By the end of January 1934 the price of gold, most of which had been confiscated by the government, was raised to $35 per ounce. In other words, in less than one year the government confiscated as much gold as it could at $20.67 an ounce and then devalued the dollar in terms of gold by almost 60%. That's one helluva tax....

"Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon..."

"The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get. The consumer price index from early 1933 through mid-1937 rose by about 15% in spite of double-digit unemployment. And that's the story."

We had no doubt that inflation can occur during a depression; hey, we read the papers. Anyone who has followed the Zimbabwe story knows that you can have a deadly depression...and dizzying levels of inflation at the same time.

But there's always more to the story. Devaluing the dollar in terms of gold had the immediate effect of increasing the money supply - it was like adding zeros to the currency.

In our wallet is a ten trillion dollar Zimbabwean bill, with a picture of stones on it. Those words - 'ten trillion' - did not get printed on that bill by accident. We assume they got printed on their by a printer in the employ of a government that figured that the cost of printing a ten trillion dollar bill was less than the cost of not printing it.

That is, by a desperate government that had so fouled-up the economy that a period of hyperinflation might seem like an improvement. Besides, hyperinflation might have a therapeutic, purgative effect.

But let us not get sidetracked by hyperinflation. It is nowhere in sight. Nor is its more civilized cousin - normal, polite inflation. The money supply in America - as measured by M2 - is contracting. The banks get money from the feds, but they don't pass it along. The chain of reflation is broken - or at least temporarily stretched. Currently, it takes a long time for money to get from one end to the other. The cash tends to get waylaid -either by the bankers...or by consumers themselves. It stays in bank vaults...or in bank accounts. Money is not being multiplied by the speed by which it changes hands. Instead, it is divided by immobility. It sits. It shrinks. It waits for a real boom.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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We began having doubts about the 'feds inflate...gold soars' hypothesis last year. It was too easy...too obvious. And if it were that easy to inflate a nation's currency, how come the Japanese couldn't get the hang of it in the '90s?

So, we moved towards a contrarian position - inflation, yes...but not for a while. And gold? Well, we are in it for the long run. In the short run, anything could happen.

To clarify our view on gold, the Daily Reckoning is not bearish on the metal. It is not bullish on the metal either. It is buggish. We are gold bugs. In the long run, gold will retain its value. Since that's all we ask of it, we are always satisfied. Even if it is down in the short run - and it went through an 18-year downcycle from 1980 to 1998 - it will come back in the long run.

Gold is not a speculation for us; it is a means of saving money. As Richard Russell says, a man should count his wealth neither in dollars nor in euros; he should count it in ounces.

Our views on gold are still contrarian. But our views on the gold market have become commonplace. Now...everyone's a contrarian. As we read the opinions and the blogs, it has become common to forecast a dip in the gold price...followed by a new, big bull market after inflation has found its footing.

And so what does gold do? It goes up!

Yesterday, gold rose $11 - still comfortably above the $1,000 mark. Is gold going up because people fear inflation? Apparently not. If they were afraid of inflation we'd see it in the bond market. But instead of selling off - which is what Treasuries should do if there were any hint of inflation - bonds are going up.

Is gold going up because people are afraid of the dollar going down? Well, maybe. But that is like saying that the dollar is going down because people are afraid the price of gold is going up. Where's the chicken? Where's the egg? Which is the cause? Which is the effect?

The dollar is still going down...as gold rises. Yesterday, it closed just below $1.48 per euro. It is so low now that Americans' cost of living is among the lowest in the world. The average house sells for just $160,000. That's just over 100,000 euros. Even out in the country...you would have to do some serious searching for a nice house anywhere in Europe that you could buy for $100,000 euros.

And what about the economy? Our contrarian position has remained unchanged. As we put it last week, there are few problems that enlightened central banking can solve; a credit contraction is not one of them. All the bankers can do is to make it worse - by delaying it, disguising it or diverting it in another direction (such as converting deflation into hyperinflation).

Yesterday, the Dow rose again - up 51 points. As far as we can tell, the rally is still on. And now, the news media and the statisticians are in full support.

House prices rose 0.3% in July. Hooray! Of course, the government is giving huge tax credits to new house buyers. Since that program began in January, an estimated 350,000 houses have been bought thanks to the program.

Household net worth also is going up for the first time in two years - at least, that's what the papers say. Of course, what do you expect? The feds are pushing up asset prices - giving them the biggest push in the history of man. But remember, the market is also doing its usual post-crash bounce. When the bounce ends...so does the temporary wealth effect...

Is this still a contrarian view? Seems to us that it's becoming more contrarian every day. The longer the rally goes on the more people think it is the real McCoy.

Stay tuned...

Bill Bonner
for The Daily Reckoning Australia

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Painting is a fairly relaxing occupation. You can do it while thinking about other things. Rolling the walls or cutting in the corners, some men might think of going hunting...or playing golf. We try to figure out what is going on in the world economy. For these are remarkable times we live in. We see what is happening...pretty much what we expected. But we're not sure where it leads.

Readers may have noticed a shift in our thinking recently. Well, you can blame latex. As we were painting in the billiard room we began to see that governments are more incompetent than even we had realized. They can't create inflation on demand. A few months ago, we were preparing for inflation...even hyperinflation. Now...we're not so sure. The depression and the Chinese vigilantes may hold off inflation...even for years.

Does this mean you should sell your gold? Well...we wouldn't go that far. Even in the Great Depression gold and gold mining stocks rose in price. And the one and only sure thing is that the world monetary system is dangerously unstable. We'd hold gold until it settles down. Just don't count on getting rich from it in the short-term.

Here's another reason housing prices are going down: housing priorities are changing. Baby Boomers are entering a phase in their lives when people typically escape from urban/suburban centers in favor of small towns and rural areas. If this pattern continues, it will mean a big shift of population, say the experts.

Remember, it's what you do, who you do it with, and where you do it that counts. By the time a person reaches middle age, the first question is usually settled...the second is often in doubt...and the third is actively being considered. That is, few people begin a new career after the age of 50...but it seems like more and more decide they might want to try life with a new partner.

"I can't imagine it," said Elizabeth. "It just seems like too big an adjustment. It took me a quarter century to get used to you. I don't know if I could get used to someone else...

"On the other hand, it might be fun to try..."

Well, for whatever reason, it seems like people are changing partners - even at a rather advanced stage in life. And as for the where to live - it's a question on practically every Baby Boomer's mind.

"I just got tired of living in the city," said a man who spent his entire career in Paris. "Just too much hassle. I'd rather visit occasionally than live there."

Our friend has moved to the country not far from here. He has set up a small woodworking shop in a garage and happily spends his time making chairs and tables. When his house is full of them, he'll probably have to give them to friends and relatives.

"It's much nicer living out here than in the city," says another friend. "And much cheaper. You can buy a whole house for half the cost of an apartment in town...and then you don't have to pay for parking...you can raise chickens and vegetables...and you can even heat with wood, if you want. You don't really have to spend much money at all.

"And the quality of life is higher. Small towns are more friendly. They're prettier...usually. They're easier. So they're perfect for people who are retired.

"And here in France, there's another phenomenon. When people retire, they want to go back to where they came from. Usually, they have a house they inherited from parents or grandparents. So, they leave the apartment in Paris to their children, who are just building their careers. And they retire to the country. It's not a bad way to live."

Until next time,

Bill Bonner
for The Daily Reckoning Australia

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