Why would you pay 40 times earnings for a homebuilder? It's a fairly easy business to enter. No barriers to entry that a little money...a few connections...and a circular saw can't overcome. With no barriers to entry, profit margins are always squeezed by competition. And growth is limited too - other builders are always starting up. If the investor paid 40 times earnings, he can only get 2.5% on his money - if the company pays out 100% in dividends! So, why pay so much?

The answer has two parts. First, China is providing stimulus to its economy on a mammoth scale. It gave the signal to its banks. The banks responded by opening the flood gates. Loans in the first half of the year measured three times those of the same period a year before. Naturally, this liquidity had an effect. The economy is booming. Everything credit can buy is being bought. But, as we at The Daily Reckoning know, you can't buy real prosperity on credit.

And the other reason for the bubble in builders' shares? Investors - especially investors in China - have learned nothing from the crash of '07-'08.

These are our little secrets, aren't they, Dear Reader? The rest of the world seems unaware of how the investment markets work...and they think credit is Miracle-Gro for the economy.

But markets are not mathematical...nor mechanical; they're moral. Their purpose is not to make people wealthy, but to make them wise. And then...only for a while.

It they were mathematical you might make people richer by adding zeros. But it's not that simple. Zimbabwe tried it; it doesn't work. A Dear Reader gave us a $10 TRILLION dollar bill - real money printed by the Zimbabwean Treasury. That - and about $5 US dollars - will buy you a cup of coffee in Harare...if they have any.

If they were purely mathematical, you might be able to anticipate price movements with computers and PhDs in math. Many have tried it. As far as we know, none has ever really succeeded.

It's not a mechanical system either. When prices go down, there are no screws you can tighten...no levers you can pull... Nor can you add more fuel or slather on more grease. It's not that simple.

Instead, markets are complex natural systems. Like mistresses, they can be jiggled and jived... but they can never really be controlled or predicted. That's what makes them so interesting, of course.

The markets are always teaching us...always correcting us...always giving us a kick in the pants. These are moral lessons...in the broad sense. That is, if you do the wrong thing you get punished for it. Step on a rake; it hits you in the face.

The purpose of a bear market is to correct the errors of the preceding boom. Most prominent among those errors is to think you can make money by speculating in the stock market. When this idea takes hold, good sense goes out the window. People will buy dotcoms with no business plans...and house builders at 40 times earnings!

But that's how we'll know when the correction is over - when people give up on the stock market...when they want nothing more to do with it. Judging by today's news...we're still a long way from there.

Get ready for another crash...the next leg down of this historic correction...the next kick in the pants...the next moral lesson.

If investors have learned nothing so far...neither have the feds. All over the world they're trying to solve a problem caused by too much credit by providing more credit. Trillions' worth, in fact...

We see the result of it in China...a country where the feds have money to spend...and the power to tell bankers what to do. The markets have gone wild...

In the United States and Britain, they've been less successful. But they haven't given up. On the contrary...they've put at risk an amount equal to nearly twice the GDP of the entire US economy...and now they're talking about Stimulus II...

Then Stimulus III...then Stimulus IV will probably follow...until the whole thing finally explodes in a blaze of glory...

Consumers have wised up. They seem to have learned their lesson. Savings rates have gone from zero to 7% in the past 12 months - a remarkable turnaround. Frugality is back in fashion. Thrift has been put back in the dictionary. Consumers are tired of carrying huge debt loads. They're eager to get rid of them as soon as they can.

But neither Wall Street, nor Washington, nor investors seemed to have learned much. Wall Street is still handing out billions in bonuses - leaving its firms short of capital reserves. Investors still seem ready to jump onto whatever wagon has the most other people on it. And while the private sector ran up trillions in debt in the bubble years; now, it's the public sector's turn.

In 1991, borrowing by government and the private sector put together was less than 5% of GDP. But by 1998, the private sector was on a binge. Every year for the following decade, households and businesses borrowed between 10% and 15% of GDP, while government continued to borrow modest amounts...less than 5% of GDP.

In 2008, the positions reversed dramatically. Private sector borrowing collapsed to below zero - meaning, the private sector was is paying off debt, not accumulating more of it. The public sector, on the other hand, has come to the rescue with borrowings between 10% and 15% of GDP.

Of course, this is classic counter-cyclical stimulus. What the private sector giveth up on...the public sector taketh up like an unexploded hand grenade. The politicians are now pulling the pin...

Yes, dear reader, there are still lessons to be learned.

But wait...isn't counter-cyclical stimulus a good thing? Everyone says so. Without it, said Ben Bernanke, we might have entered a Second Great Depression. And we don't know...maybe he's right. The private sector is no longer borrowing and spending like it used to; now, the feds have to do it, right?

Where have you been, dear reader? That's not the way it works. The credit explosion in the bubble years didn't really make households richer - it made them poorer. That's why they're struggling to pay their bills now. And the credit explosion in the public sector now isn't going to make people richer either; it's going to make them poorer too. Soon, the United States will be struggling to pay its debts too.

That's the moral lesson: borrowing makes you poorer. Unless you're using the money to increase output, there's no economic health it in. In other words, if a factory sees an opportunity, it might borrow to expand. The extra output should produce enough profit to allow it to repay the loan...and come out ahead. But if you borrow to consume, at the end of the day you're poorer. That's the lesson of the Bubble Years. That's the lesson consumers need to learn every couple of generations. And now, they seem to have learned it. They remember that the economy ran hot in the bubble époque, but it didn't do them any good. And while the stimulus of that era did stimulate consumption, it was not genuine wealth building.

And now cometh the feds. They're borrowing and spending on a scale never before seen. The federal deficit is expected to come to $2 trillion this year. Trillion-dollar deficits are foreseen for the next 10 years. There seems to be no way out.

What the private sector took away - about $1.4 trillion of debt-induced spending - the public sector puts back. But will this spending produce any more real wealth than the private sector binge? Let's see...the news reports tell us they are using it to fix toilets in national parks...cut down pine trees in rural Tennessee...and bail out the bankers on Wall Street. Is this consumption or investment? If it is investment, is it wise investment? It's not enough to invest; you have to put money into projects that pay off...that pay dividends...projects that give you the cashflow to pay back the debt! Will federal spending for the stimulus/bailout projects do that?

Don't even wait for the answer, dear reader; you already know what it is.

Tomorrow...the vigilantes are back...the real showdown...

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Government Debt
• Things That Matter in the Economy are Going in the Wrong Direction
• Have the Feds Given the Economy a Miracle Drug?
• One of the Biggest Humbugs in Capitalism is Private Equity
• The French are Feeling Pretty Smug

Normally, small businesses lead the economy out of recession. But this is no normal recession. This is a depression. And small businesses are getting crushed. An AP report says small businesses are not bouncing back as hoped.

Part of the phenomenon can be explained merely by the severity of the downturn. If this were a recession it would be a bad one - worse than any since the Great Depression. Consumers have rediscovered thrift. Households are cutting back. They do this by eliminating things that aren't necessary. Small enterprises often provide things that people don't really need to have.

Another explanation involves the feds' response to the slump. Never before have they fought so hard to avoid a capitalist correction. But in their efforts to bailout Wall Street they not only ignore the side streets and back alleys where small businesses operate, they actually take away money from what might be called the small business economy in order to pay off their friends on Wall Street.

This is how you put the 'great' into a Great Depression - by depriving the small business sector of the capital and freedom it needs to innovate and grow.

Bill Bonner
for The Daily Reckoning Australia

• The Olympic Torch Passes by Daily Reckoning Offices
• Bubble Age Jobs Lost Because of Recession
• Japan and its Economy Did Not Have Secret to Everlasting Success
• Stocks, Bonds and Economy All Bounce
• Small Caps to Lead the Way in 2009

There are, I know, politicians and pundits who blame the financial crisis on a "lack of regulation." Frankly, anybody who says that has failed the IQ test, or perhaps the ethics test. For all practical purposes, the American banking system is a branch of the federal government. It has been for decades.

Without government guarantees, backed by taxpayers, Fannie Mae and Freddie Mac could not have attracted the level of investor trust they did. The subprime mortgage and housing bubble wouldn't have been funded. Nor would politicians have had the leverage to pressure banks into offering bad loans. Perhaps most importantly, financial institutions would have had no reason to lavish huge campaign contributions and cushy make-work jobs on the political classes.

The banking crisis, however, is not my primary concern right now. It's happened, despite numerous warnings for years from rational economists and commentators. And it will pass. It is a structural problem, and restructuring is happening even now.

The so-called bailout will delay the emergence of new institutions, but it won't stop it. Alternative institutions are rising that will avoid many of the past mistakes. Some are likely to be offshore. Even Vladimir Putin is talking about metal-backed currencies. It is ironic evidence that others are learning the lessons our political class has forgotten.

My concern at the moment is the federal budget and ongoing deficits. This new expansion of government spending and debt is not some one-time event that markets can repair. According to the Congressional Budget Office, current annual deficits have quadrupled. Independent CBO economists forecast that they will level out in a decade to about triple pre-stimulus levels.

Frankly, I failed to predict the magnitude of these budget increases coming. I expected increases and never believed candidate Obama when he promised to cut net spending. Neither, however, did I imagine he would increase it as much as he has.

It is inevitable, however, that this level of spending will be reduced. It will happen for a variety of reasons. For one, such levels will slow the economic growth Americans are used to. It will stifle productivity and reduce income tax revenues. As it always has before, this will send the political pendulum swinging away from big government.

Incidentally, claims that the spending increases are either a "bailout" or a "stimulus" are bilge. No one has ever seriously tried to explain how spending that does not take place currently can appreciably stimulate the economy in the short run. Still, less than 24% of the stimulus will occur this year. That other 76% stimulates nothing but advocates of government spending.

So today, I want to take the time to deal in some depth with the effects all this will have on breakthrough technologies. I realize, incidentally, that some of my comments may be interpreted as partisan. They shouldn't be. I was a critic of President Bush's spending record as well, though it pales compared with current levels. And for the record, I don't think I've ever registered with either major party, even when I was working with a candidate in the last presidential campaign. He was a Republican, but he understands Federalist principles that would have limited the power of the GOP.

I would gladly vote for the sort of tax-cutting Democrat my father was. Ours was a loyalist Democratic household and my parents revered John F. Kennedy - one of America's great tax cutters. His across-the-board tax cuts were greater proportionately than those passed during the Bush administration. They were enormously successful in promoting spending and economic growth. Give me a Kennedy over a Nixon any day.

Nevertheless, I am prepared for e-mail from those who mistake my criticism of destructively high taxes for partisanship. It's not. Honestly. Economics is called the "dismal science" for a reason. And it often falls to rational economists to play the role of parent, explaining that we just can't afford all those cool toys people want right now.

The term "dismal science," by the way, was coined by a Victorian historian describing the work of Thomas Malthus. Malthus set the standard for doom and gloomers. An Anglican minister and a terrible economist, he predicted the imminent destruction of civilization, if not humanity itself, in the late 1700s. Despite our survival and amazing progress since then, others make similar predictions to this day.

I am, in fact, optimistic about the long run. The economy will not only recover. It will continue to grow exponentially when it does. That doesn't, however, mean that we don't face serious challenges in the short to medium run. This, however, is a unique time historically, with unprecedented opportunities for patient farsighted investors. Rahm Emanuel and Hillary Clinton have both said that you should never let a good crisis be wasted. Though my means of exploiting the crisis are quite different than theirs, I agree with the general sentiment.

There will, however, be delays in technology development. Because so many of the emerging breakthrough technologies today are related to health and longevity, I take those delays personally. While the economy will recover, there are people who will miss out on lifesaving therapies because new technologies are not being funded. This irritates me.

Nevertheless, we need to look at the situation clear-eyed and figure out how to profit from it. And in the process, we may help move some of these revolutionary new technologies forward. There is another Chinese proverb about crises creating opportunity, and this is no exception.

Now, to business.

The most onerous impact of excessive federal spending is the absorption of capital. When finite capital is appropriated through taxation and federal debt creation, this necessarily reduces the level of funding available for research and development.

This simple math is ignored by those who believe it's a good thing to tax the rich, the people who direct most investment capital into emerging technologies. Historically, overall economic well-being is best accomplished through the promotion of new technologies and businesses. Kennedy made that point with his famous statement that "rising tides lift all boats." Right now, the deficit is lowering the tide. Until this sapping of our R&D lifeblood is rectified, transformational technologies will face challenges.

Typically, we know, investors abandon unproven sectors for traditional stability when things get scary. This includes even venture capitalists. New data from PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters verify that this is the case.

In the first quarter this year, US venture capital investments fell 61%. In the same quarter a year ago, venture investments were $7.74 billion. This year, the total was barely $3 billion. This is the lowest level in 12 years. Acquisitions of venture-backed companies fell by nearly half from last year. There were no venture-backed IPOs. None.

The one notable bright spot in this picture is health care services. Venture capital investment there is actually up somewhat. As I wrote on several occasions while we were waiting for the train wreck, health care is countercyclical. When times gets tough, the last thing consumers cut back on is medical services.

This is one reason that my Breakthrough Technology Alert portfolio is so heavily weighted with medical biotech today. It's not the only reason, however. It is simply true that a huge percentage of the biggest and most profitable technologies on the near horizon are medical. Significantly longer healthy life, i.e. "time," is the product they will deliver.

Economists talk about the "backward-bending demand curve." It refers to the fact that we max out on stuff. Eventually, if we get enough of something, we value additional units less. Demand for life, however, is unlike any other good or service. It is, in effect, infinite.

Regards,

Patrick Cox
for The Daily Reckoning Australia

• Kennedy and Public Service
• U.S. Government Spending $13 trillion to ‘Fix’ Problems
• Debt Backed Securities Face Deepening Trouble
• The Obama Administration’s Impact on Nuclear Energy
• President Barack Obama and Franklin Roosevelt Are Becoming Akin

What we're talking about are Ben Bernanke's comments. The news headlines read that he predicted the recession will end later this year and the American economy will recover in 2010. But that's not exactly what he said.

Here exactly is what he said, "If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stabilityand only if that is the case, in my viewthere is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery."

If you wanted to put it another way, it might go like this: If our plan is successful to solve all the problems, then all the problems will have been successfully solved according to the plan.

How inspiring is that? Does it give you confidence that these guys have any idea what they're doing?

What the system needs is more instability, not less. That is, prices and asset values need to fall to their real level to restore confidence. In this sense, a proper recession is the cure for uncertainty and instability.

Yes, we know this is in direct contradiction to what elected officials are telling you. But think for a moment of a man who's done nothing but eat greasy and fatty foods for a year. He's on his deathbed. His arteries are clogged with fat and cholesterol.

Now you couldn't improve the man's health by telling him to feel better about himself. "C'mon big fella. Buck up! Have another cheese burger. With bacon. And avocado. This whole being morbidly obese and killing yourself thing is all in your head. You gotta get your mind right!"

You could tell him all that. But it would be bad medical advice. In the same way, our financial mal-practitioners have mis-diagnosed the economy. Confidence is not the problem. Bad credits and loans are the problem.

You restore confidence when you directly address the problem. Investors get out of cash and back into shares or property when they have demonstrable proof that the banks aren't hiding/lying any longer.

Or, as Murray Rothbard puts it in America's Great Depression, "The completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers' scramble for cash. A rapid unhampered fall in prices, both in general, and in particularly in goods of higher orders (adjusting to the mal-investments of the boom) will speedily end the realignment processes and remove expectations of further declines."

But instead of realigning with economic reality, our policy makers are acting as if it is possible to sustain all the bad investments made during the credit boom. They want to save homeowners, shareholders, bondholders, and pretty much anyone who stands to lose from the risks gone bad.

That is not possible. Someone has to pay for the bad bets made in subprime loans, Eastern Europe, or the developing world. That someone is probably a) the guy who took out the mortgage he can't repay, b) the bank who made the loan to the guy who took out the mortgage he can't repay, c) the investor who bought the bond sold by the bank who made the loan to the guy who took out the mortgage he can't repay.

Evading responsibility for one's actions doesn't solve anything. Making other people pay for them doesn't help much either. Of course we're all going to pay for it one way or another, through more bailouts or the general contraction in credit and growth that has to come during the "realignment process."

But those appear to be the two choices: allow failure, which allocates resources from the bad debts and losers to those who can produce real wealth. Or, try to "stabilise" any inherently unstable situation (perpetuating asset values after the credit spigot has been turned off).

Not that we're absolving market institutions for getting us into the problem. The credit ratings agencies essentially sold investment grade ratings on issues they didn't or couldn't understand. AIG sold default insurance on CDOs to make an easy buck. It's now become a black hole for taxpayer capital.

But that is fictitious financial capitalism at work, or at waste if you prefer. That kind of financial capitalism is dead, and good riddance. But don't mistake that episode of mismanagement and theft for conclusive proof that "capitalism" has failed. That would be a big mistake.

But the commies are feeling their oats these days. Yes, the commies are back in the DR mailbox. They're in the paper. They're even on TV. We saw a report on them last night and how their explanation of the financial crisis validates what they've been saying all along.

--In fact, a few readers stormed the barricades yesterday in response to our debunking of the Marx quote.

"Karl Marx did write this prediction and many communists have repeated it over and over. No really educated person believes that Capitalism can possible [sic] work, it never has. it is invented by the jews as part of Christianity. Your reckoner has almost nothing to learn from. Cancell [sic] my membership please.

Kenneth Seaton

With pleasure Mr. Seaton. Had we known you thought this way, we would have done it pre-emptively a long time ago. We wouldn't want to be a member of any club which would have you.

And why is it that instead of making real arguments, you simply assert that an educated person couldn't possibly believe in capitalism? It doesn't require belief. There's plenty of proof around you in the global economy. Go in peace Mr. Seaton, and never come back. Please.

"Surely you jest the current financial crash is due entirely to the market and it's [sic] insatiable greed, regardless of the cost to the rest of society. I've never heard anything so stupid as your puerile explanation of the boom bust cycle being the product of governments manipulating interests rates. Interest rates are determined by central banks and the market. The boom bust cycle has always been a characteristic of capitalism, get used to it. Whether you like it or not the cause of the financial collapse (and it will get worse before it slowly starts to recover) is the sole making of the free market and the crazies who ran the merchant banks and AIG.

And for the record you should take the time to read Marx. The translation from German to English is nowhere near as tortuous as your Fox channel economics. Is Rupert Murdoch the new economic guru??? How about some proper analysis for a change and drop the ideological nonsense. Morons!!!!Now where did that come from.

David Baker

It's hard to imagine, having written a letter like that, that you'd ever get any enjoyment whatsoever from reading the Daily Reckoning. Why do you torture yourself?

It wasn't our idea that manipulation of interest rates perverts the business cycle. It was the Austrians. We'll have more for you on that tomorrow. As for the moron comment, you can never say often enough about politicians, even though it's way too kind.

• Did Marx Know All This Was Coming?
• The Banks Should Hold More Capital
• The “Consumer Economy” Was Always a Mockery
• Capitalism and Capitalists
• Fractional Banking and Our Own Emotions Are Working Against Us

"Once envied, Wall Street bankers are now mocked," says a headline at the International Herald Tribune.

So many people are getting on the bankers' case; we're beginning to feel sorry for them. After all, what did they do wrong?

Well...they floated the whole world economy on a sea of debt... even making loans to people they knew were going to sink.

And they took bonuses on profits they hadn't actually earned.

And they paid themselves the cash that their banks now desperately need.

And, they created trillion-dollar debt torpedoes - which are now exploding all over the planet, leading to $32 trillion in losses...so far.

And they set the stage for a cycle of mass unemployment, strikes, depression, protectionism, riots, revolutions, poverty and probably even starvation.

And, oh yes, they blew up their own banks too.

But aside from that, they are pretty decent fellows, no? More about bankers and CEOs...below...

Meanwhile, in Spain, unemployment grew 47 % in the last 12 months. 14% of the workforce is out of a job.

In Ireland, "public sector workers face pay cut," says the Financial Times. The Irish government is running out of time and money.

In China, 20 million people have had to give up their city jobs and go back to the countryside in search of work.

IBM says it cut salaries by 15%. UPS said it froze its payroll.

U.S. property owners lost $3.3 trillion last year, says Bloomberg. Houses in Las Vegas fell 41%. In Phoenix, they went down 43%. Miami homeowners saw a 40% decline.

But yesterday, investors thought they saw a little light on the horizon...perhaps a rescue ship? The number of pending sales, of existing houses, actually went up in December. This was enough, according to the press reports, to bring them back into the stock market and raise the Dow 141 points.

Oil held steady at $40. And gold rose $14 to $892.

Our guess is that the little light investors thought they saw will turn out to be another torpedo blowing up. Millions of homeowners and stock market investors have gone down already...but there are many still afloat. And many torpedoes that still haven't found their marks.

In Japan, for example, property prices began falling in 1991. They fell for the next 13 years...reaching a low in 2004 equal to where they had been in 1973!

If that pattern plays out in the United States, the housing market won't hit bottom until 2020...when you'll be able to sell your house for what you paid for it in 1989.

As for stocks...

"Despite the vicious bear market we experienced in 2008," writes our old friend Marc Faber, "the Dow Jones in real terms is still higher than at its 1929 and 1966 peaks."

Marc admits that the inflation adjustment figures - provided by the people who create the inflation - may not be perfectly accurate. But even if you adjust the numbers to much higher levels of inflation since '29, "stocks in real terms would still be nowhere near their 1932 or 1982 lows."

You can avoid the fuzziness caused by inflation by looking at the price of stocks in terms of gold. Over the very, very long term, gold holds its value. An ounce of gold buys about as much stuff now as it did during the reign of Julius Caesar. How could that be? The explanation is simple: mankind adds to the quantity of gold above ground at about the same rate that it adds other goods and services.

That doesn't mean that gold's price is stable - far from it. The price goes up and down - depending on what else is going on. Generally, the more confidence people have in the financial system, the less need they have for gold. But over the long run gold has been the world's most reliable, most universal store of value.

The stock market low of the early '80s coincided with a low-ebb of confidence in the dollar and in bonds. At one point, the price of gold rose over to $800 an ounce...while the Dow fell to 776. That one-to-one ratio marked a turning point. Thence, stocks soared and gold fell.

The next turning point came 17 years later - in 1999 - when gold was back to $260 and the Dow was over 10,000. At the peak, it took 43 ounces of gold to buy the Dow stocks.

Since then, gold has been in a bull market, while stocks have declined. But even now, it still takes about 10 ounces of gold to buy the Dow stocks. Which tells us that this correction still has a long way to go. Wait until the Dow and gold reach the same number...then, the light you see on the horizon may be daylight.

*** The Singularity is Near is a book by Ray Kurzweil. It refers to a time - in the not-too-distant future - when machines will be smarter than bankers. And now, the Financial Times tells us that the moment is not far off - only a few years. Then, machines "will solve problems including energy scarcity, climate change and hunger."

Which makes us wonder; what's in that pink ink? Something is addling brains at the FT. Machines can already think better than humans. That is, they can already do calculations faster than we can. And they can remember things better too. And, using Google, they can find things and make connections faster.

Machines can help build safer bridges. They can help cure diseases. They can play chess and tell you where you left your car keys. But they can't solve social and political problems...at least not directly. A smart computer could help build a more energy efficient automobile, but it can't solve the problem of energy scarcity. Because there isn't really an energy scarcity problem. Engineers, technicians and businessmen produce and sell energy - just like they produce and sell diamonds or custard pies. Stuff - including energy - is always 'scarce.' Even sand is scarce. The Sahara may be full of it; but when you want some for your backyard, it won't be free. Machines - as smart as they are - can't solve this 'problem.' Resources are allocated either by the invisible hand - the give and take of free people - or by the heavy hand of whoever is in power. Smart machines aren't going to change that.

*** "The Great Repression" Niall Ferguson calls it. He's referring to the fixers' attempts to stop the correction. Ferguson favors treating the oversized debt with a mixture of boondogglization and liquidation. He thinks the state should take over banks...recapitalize them...and re-privatize them "say in 10 years."

"Honor the rule of law...in the breach," he continues, oxymoronically. He would simply force mortgage-holders to accept new terms and conditions - notably a much lower interest rate. This would lower homeowners' payments, thus allowing more of them to hold onto their houses. In effect, he proposes a kind of pre-emptive default...like removing a man's kidneys before he is dead...or having a cigarette before making love. By order of the government, a portion of the mortgage's value would be liquidated...stiffing the lenders, but favoring the borrowers.

*** In the complaints about corporate pay comes a tedious refrain. Corporate jets are a "symbol of greed and excess," says a Financial Times comment.

But this time, the FT comes to defend the CEOs: "The reality is that boards that lavish tens of millions on a top executive would be squandering resources by asking them to spend precious hours in security-obsessed airports..." continues the report.

Again, we wonder what has gone wrong at the FT. Have they ever spent any time with a "top CEO?" In our experience, a CEO's time is taken up with countless meetings...countless conferences...luncheons...phone calls...briefings and reports. A corporate jet is a marvelous addition to his routine. It enables him to fly off to yet more meetings...while having a staff conference en route. Then, when he arrives at the airport, a limousine awaits him...with yet another person with whom he must meet ...along with briefing papers and preparation documents for his next rendezvous.

If he is aggressive and acquisitive, one flight will take him to a meeting with lawyers, where he will discuss the strategy of a takeover. The next flight will take him to a meeting with the financiers, where he will discuss the terms of the options and other emoluments to be distributed. And yet another flight will take him to a meeting with investors...where he will recite the lines given him, with authority and confidence. His firm is not merely in pursuit of excellence, he will tell his audience; it IS excellence embodied. Just look at the last quarter's results!

All of this makes him feel terribly important...and it describes the life of the typical Wall Street big shot during the bubble years.

Too bad corporate boards didn't cancel the jets 10 years ago. Maybe...sitting in an airport without an Internet connection, the CEOs might have had a moment to think. About how little they really understood about their own businesses... About what mediocre clowns and connivers they really were. About how markets routinely turn geniuses into morons and heroes into schmucks. And maybe...maybe a bright light might have shone forth from their reflections...causing them to realize that they were on a flight to Hell.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• All Ordinaries Reach 52 Week Low
• Bailout on Wall Street Has Left the Door Open for Other Industries
• After the Bailout of Wall Street, Everybody Wants Cash
• Illegal Gold Mining
• Ranting Against Free markets and Wall Street

This just in:

We have it from our usually unreliable source in Washington that Gideon Gono, now head of the Zimbabwean central bank, has been called in to aid the Obama Administration. In secret talks, Gono has agreed to replace the out-going Ben Bernanke, who is said to be going to work as a helicopter pilot. Gono will take over the Fed. And a new bill has already been designed - our source was able to sneak out a copy of the new note - for 1 million U.S. dollars. That's Gideon Gono's picture on it.

According to reports, Gono insisted on getting his face on the bill as part of the deal. "Dead presidents are a dime a dozen," he is said to have remarked. "And this is just the beginning; we can add zeros later."

Gono was in the news yesterday for other reasons too. Zimbabwe has taken a couple of bold steps recently. First, it announced that henceforth citizens would be allowed to use currency other than the stuff produced by its own central bank. This came as a great relief to the people of the nation - who were already using U.S. dollars to replace the Zimbabwean brand. With 230 million percent inflation, the Zimbabwe dollar has not been so much a store of value but an incinerator of it. Second, Gono announced that he was taking 12 zeros off the Zimbabwean currency. Twelve seems like a lot. And it seems like only yesterday that Gono introduced the first note with 12 zeros on it - the 1 trillion Zim dollar note.

But that's the problem with zeros. They've got holes in them. You add nothin' to nothin' and you still got nothin'. Easy come. Easy go. You can as easily add zeros as take them off. At the end of the day, the extra zero gets you zilch.

Still, dear reader....

In Gono We Trust. Our economy is in a terrible mess. We need inflation; only Gono seems to know how to get it.

Yesterday, the report card on the economy came in. It showed growth in the last quarter of last year at MINUS 3.8%. "Could have been worse," say economists. It WILL be worse, we reply. This Depression is just getting started.

The Dow fell 40 points yesterday. We're in February already. Investors look back and see that stocks have lost more than 8% so far this year - the worst on record. In 87% of cases, what goes down in January goes down all year long. Last year, we had the worst stock market performance on record. But what the heck...records are made to be broken. This year will probably be worse still.

Macy's said it laid off 7,000 people. California says it is kiting checks. And Republicans say they are digging in their heels about Obama's Bailout Boondogglization program. They favor boondoggles of their own.

Consumer spending fell last month - for the 6th month in a row. Consumers are exhibiting the quality that economists fear... "the propensity to save." Until last year, of course, they had a propensity to spend. Now, all the news tells us that what ought to happen is happening now; consumers are closing their pocketbooks.

According to mainstream economists, this "propensity to save" thing is as welcome as halitosis. It's a conversation stopper, for sure. One man's expiration is another's inspiration. One's spending is another's income, in other words. So when he stops spending, the whole system of consumer spending comes to a halt. Sales plummet. Incomes fall. Jobs are lost.

Hey...welcome to the Depression of 2008-? And get ready to welcome Gideon Gono to the Fed. We need him.

*** Yesterday, we promised to take up a theme...hmmmm....what was it...? Oh yes, the critical issue...when.

When? When what?

Oh yes...when will deflation turn into inflation?

You want a date, don't you dear reader? You want to know exactly when you should switch out of Treasury bonds and into stocks, gold and freeze-dried food. Alas, that we can't give you. Not even an approximate date.

This past weekend, we sat down in the Dr. Richebacher chair that we keep next to the fireplace. It's the chair where Kurt Richebacher used to do his heavy thinking. We inherited it from the family after he died.

We sat and we tried to channel Kurt. What would he think...we wondered.

"Imagine you are in a small town," we thought we heard him say. "Imagine that the banker printed up the town's money in his basement. One day, he went a little crazy and started making huge loans, even to unqualified borrowers, at very low rates of interest. You would soon have a boom on your hands, with everyone paying for everything with IOUs, all derived from the bank's easy credit policy. But, eventually, when it was discovered that people couldn't repay their loans, there would be a terrible bust.

"That is where you are now. (I say 'you,' because I am no longer among the living...but I have to say, heaven is not a bad place to be... There is almost a total absence of economists, lawyers...and not a politician anywhere.) It is a period of price discovery in the credit market...because no one knows who can pay his bills and who can't. The IOUs are being marked down. Unemployment is rising, too, as the local economy slows down. Consumer demand has been greatly reduced as every has gotten poorer.

"Now, the banker sees what a mess the place has become. Naturally, he wants to do what he can. He tries to lend more money, but people have been down that road; they are reluctant to borrow. Then, he undertakes to build a new ballpark...you know, for playing baseball. And he decides to upgrade the town hall too...printing up the money to pay for it, as necessary, and to pay for a variety of projects to keep his friends and relatives employed.

"But while he is trying to get the boom going again, the bust is still going on. For every dollar he puts back into the town economy, $2 or $3 is taken out. Instead, of spending money like they used to...citizens stuff it in mattresses and bank accounts (much of it comes back to the bank where it started!)

"This process can go on for much longer than you think. Because the banker is, in effect, standing in the way of what needs to happen. He is blocking the process of price discovery...by lending money to deadbeat debtors and propping up businesses that are no longer profitable. The baker, for example, had built a fancy oven to produce 200 pastries every day. When the boom was in full swing, he sold every one of them. But now that people are cutting back, he sells only half as many. His investment in the new oven is now a losing proposition. But it takes the market a long time to find out; because the banker gives him enough money to carry on...when he should have declared bankruptcy months ago. And so with the tailor and the hat-maker and all the rest.

"Eventually, the banker realizes that his efforts to restart the boom have failed. Instead of spending money, people use it to pay down their debts. They cut their expenses; they reduce their output; and they'll continue to use their cash surpluses to pay their debts until they are back down to where they usually are, he reasons. Even then, people are likely to save because they've gotten in the habit of saving; this could go on for a long time, he figures.

"And then, he realizes that the only way to prevent people from falling into the 'propensity to save' trap is to make them realize that the currency is not worth saving...that it is losing value. That is when he will turn to Gonoism. He will go down into the basement; print up stacks of $100 bills...and begin passing them out on street-corners."

Inflation is needed. Not just more credit from the bank. But money...cash...free cash...piles of it.

The U.S. currently has about $1 trillion worth of spare output capacity. It has about $6 trillion worth of private debt - above and beyond what is traditionally considered 'normal.' And unemployment is rising. As long as those things persist, prices are not likely to go up. First, because business has no pricing power - not when there is excess capacity. In our example above, for instance, the baker can double his output of pastries with no further investment nor additional costs. He cannot raise prices; instead, he'll probably lower them in order to compete with the baker down the street who also has excess capacity. Nor are labor rates going to go up - not when workers are still being laid off. The proletariat has no more pricing power than the bourgeoisie. And as for consumers...they won't go back to consuming until they've lightened their debt burden. With $6 trillion, more or less, to unload it will be a long time before they're ready to spend again.

So don't expect miracles from the Boondogglization programs. Prices won't rise until central bankers Go Gono. And once they've gone Gono...things will really start to pop! Stay tuned.

*** Our friend, Nassim Taleb, author of the The Black Swan , told the Davos crew that "we should not trust these bankers. Look at their track record. The only way to stop the process is for the government to own those banks."

Yes, dear reader, everyone is jumping all over the bankers. As we pointed out two weeks ago, there are two schools of thought. Either the bankers are evil. Or they are just very, very stupid.

Jamie Dimon, chief of JPMorgan Chase, joined the 'they are stupid' camp.

"God knows, some really stupid things were done by American banks and by American investment banks," he said. But he went on to suggest that maybe the bankers weren't the only morons. "To policy makers, I say: 'Where were they?'"

The grammar suggests he really is stupid enough to be a politician. He probably meant to say: "To policy makers, I say: "Where were YOU?"

But the thought seems correct to us. Where were the regulators...the policy makers...the economists...the commentators...the media...the analysts...the rating agencies? And where were investors? Of course, they were all in the same place as the bankers - fantasyland.

And now, guess what? They're still in fantasyland...imaging that these trillion-dollar boondoggles will erase the mistakes caused by their earlier fantasy.

Oh, Mr. Gono, wherefore art thou?

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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But he hung around with the wrong crowd - lowbred types in high political circles - and look where it has gotten him. Tomorrow, he'll be called upon to stand before a hundred million viewers, put his hand on a Bible, and lie.

To the question - will he swear to uphold the Constitution of the United States America - he will give the answer he has rehearsed. Yes, I can! Then, like almost every American president since John Quincy Adams, he will ignore it.

But before we return to tomorrow, let's turn back to yesterday…or, Friday. So far this year, stocks are down nearly 7%. But at least the Dow bounced a little at the end of last week - up 68 points.

Oil held at $42. And dollar was steady at $1.33 per euro.

The excitement on Friday was in the gold market - the yellow stuff bounced $32. Why would gold go up…when the world economy is clearly going down? We don't know. But if we were Mr. Obama, we'd approach this new job like renting a car from a disreputable agency. We'd want to take a good look and take note of all the dents and defects before driving off the lot. We wouldn't want to get charged for the previous drivers' mishaps!

The founding charter of the U.S.A. made no allowance for going into the banking business…nor the auto business…nor any other kind of business. Neither did it allow invasions of foreign countries, without a declaration of war…or imagine a standing army that costs about as much as all the rest of the world's armies put together.

In the beginning, the U.S. government was specifically limited in what it could do. Now, very little remains that it can't do. But in all matters - big or small…torturing people or taking their money - government leaders must pretend to be acting in the national interest. It's a low-down, dirty business that usually attracts people of the same sort. People like George W. Bush and Joseph Biden…people with no sense or no principles - or neither. People who don't know a lie when they hear it or…don't mind telling one.

That's why we're sorry to seem Obama in the trade; he seems like such a nice fellow.

But politics…alas, someone's got to do it. As the old Latin expression puts it: The voters want to be deceived; then let them be deceived.

So many patsies…so little time. Bernie Madoff could barely keep up with all the people who wanted to give him money. The hopefuls joined his Palm Beach country club just for the opportunity to slip a few extra large bills in his pocket. Old buddies sought him out…eager to part with their entire fortunes.

And look at the Treasury market! The patsies line up to buy I.O.U.s from a deadbeat debtor who already owes money all over town. And now he's passing out more I.O.Us…at a faster and faster pace…trillions of dollars' worth of them. Not only that, the debtor in question has said publicly that he intends to lower the value of his paper - at all costs.

And now the voters…the general public…the lumphouseholders - they're dying for a lie too. They want someone to tell them that he's got the recession under control.

Well, if they're going to be deceived someone's got to tell them lies. Barack…you're up!

The people want to believe that if the president weren't such a screw-up, we wouldn't be in this mess. In other words, if the administration would get its act together, it could "do something" to get the good, ol' times back.

Rarely do we get an opportunity to come to the defense of George W. Bush. But here we will say without equivocation: this financial crisis is not his fault.

Sure, he made it worse by wasting $2 trillion on that silly war of his - the 'war against terror.' And sure, he should have gotten rid of Alan Greenspan at the beginning of his term…and he should never have signed so many spending bills without a fight. And, it's too bad he didn't understand what was going on in the financial sector and warn people - instead of jawing on about how great the U.S. economy was. But, heck, who did? He acted like a moron; no doubt about it. But who didn't?

So give George W. Bush a break. Let the man skulk back to the ranch without trying to pin this financial collapse on him. He didn't cause the problems; and he couldn't cure them either. The financial problems faced by the U.S.A. cannot be solved by politicians. They can only be made worse by politicians.

The problem is that there are a lot of bad loans, bad investments and bad businesses that need to be cleaned out. All the politicians can do is to try to prevent the clean up…

*** The lumpen want to be deceived; so the politicians take it as an opportunity. Last October, for example, they raided the Treasury for $700 billion that they could pass out to their friends on Wall Street. Of course, that program was supposed to be in the 'national interest.' The banks were supposed to lend the money out to the taxpayers whence it came.

As absurd as it sounds, and as unconstitutional as it surely is, it is nevertheless the law of the land. And now that a few months have passed…and a few hundred billion have been passed around, we're beginning to understand what happened to it.

The New York Times reports:

"Speaking at the FBR Capital Markets conference in New York in December, Walter M. Pressey, president of Boston Private Wealth Management, a healthy bank with a mostly affluent clientele, said there were no immediate plans to do much with the $154 million it received from the Treasury.

"'With that capital in hand, not only do we feel comfortable that we can ride out the recession,' he said, 'but we also feel that we'll be in a position to take advantage of opportunities that present themselves once this recession is sorted out.'

"'The Treasury secretary, Henry M. Paulson Jr., said in October that banks should 'deploy, not hoard' the money to build confidence and increase lending. He added: 'We expect all participating banks to continue to strengthen their efforts to help struggling homeowners who can afford their homes avoid foreclosure.'

"But a Congressional oversight panel reported on Jan. 9 that it found no evidence the bailout program had been used to prevent foreclosures, raising questions about whether the Treasury has complied with the law's requirement that it develop a "plan that seeks to maximize assistance for homeowners."

What did they think? Bankers don't make loans in the hopes of getting 'good citizenship' awards. They lend money when they think they can make money at it. Now, with so many balance sheets in such bad condition, they are afraid their loans won't be repaid.

Typically, Thomas L. Friedman has a solution. The president should get 300 banking presidents in a room and give them a "come to Jesus" speech, he says. By that, he means the feds should play a more muscular role in the banking crisis. Good banks should be saved. Bad banks should be dissolved.

And what about all those bad loans? Ah…the New York Times columnist has a solution for that problem too. The government should buy them up…hold them…and then "sell them later when the market rebounds."

See how easy it is, dear reader. Problem solved. That's what Obama should promise the voters.

And if the patsies will believe that…maybe they'll kick in a few hundred billion more for Wall Street.

Bill Bonner
for The Daily Reckoning Australia

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"Despite the Federal Reserve's dramatic efforts to shake loose the financial system, banks still can't come up with accurate prices for hundreds of billions of dollars' worth of mortgage securities, corporate loans and other assets."

These assets that can't be traded and which no one wants to buy are called Level Three assets, named for the part of the balance sheet on which they reside. The banks have stuck them there the way some people might stick a crazy Aunt in the attic to avoid being embarrassed in front of the neighbours. Shut up Aunt Tilda!

There are a lot of Aunts in the attic. "Level 3 assets now make up 13% of the $771 billion of assets Goldman holds at fair value, according to regulatory filings. Of the $96 billion, Goldman is on the hook itself for $82 billion, and that 'economic exposure' is up 50% from the fourth quarter." And it's not just Goldman.

"The increases from the fourth quarter in Level 3 exposures weren't as stark at Morgan Stanley or at Lehman Brothers. Morgan Stanley had $78 billion of Level 3 assets, or 17% of its assets held at fair value, up 6% from last November. Lehman had $42.5 billion in Level 3 assets, 14% of assets held at fair value, up 1% from November. The three investment banks are the first of a series of banks to file their quarterly reports detailing Level 3 exposures. The total is only expected to rise."

Well that's not good news. We were asked yesterday if the Day of Reckoning for the banks and brokers has been postponed by Fed action. The trouble is these Level Three assets aren't going away. The banks, the Fed, and the brokers hope that by letting these sleeping dogs lie, they will eventually wake up and not be any particular harm to anyone.

They hope that by stashing the loans out of sight, investors will stop worrying about them and get back to buying stocks. But three-day old fish doesn't get fresher or more appetizing just because you've hidden the refrigerator in the back room. Yet that seems to be the solution pursued by the Fed and the banks.

Instead of chucking out the garbage loans, the Fed wants to put all the garbage in a hermetically sealed room deep in the bowels of its offices in New York. But just because you can't see something doesn't mean it's stopped stinking.

Eventually, we reckon the Feds will approve of, or even create, new off-balance sheet vehicles for banks to keep these garbage loans in. The loans won't count against the bank's capital requirements. And like a bad memory, the bad loans will be forgotten, sequestered away in their own quiet little cavern like so much captured carbon dioxide.

But this unwillingness to deal directly with the bad loan problem and write down the value of level three assets does not bode well for the U.S. dollar or dollar denominated assets.

Dan Denning
The Daily Reckoning Australia

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As the quarter unfolded, it became clear that the world’s credit system was drifting aimlessly, like a ship sailing with no wind. A lot of business that should have gotten done just did not happen, for lack of funding. Funding went away because risk aversion kicked in with a vengeance, and for a very real reason.

The last 12 months or so have been a time of repricing risk – and this occurred on a global scale. But the repricing was not orderly. The U.S. dollar was steadily drifting downward in value, and prices for most things were readjusting just on this monetary basis alone. Add to this some severe industrial disruptions, from power shortages in South Africa to floods in Australia to economy-stopping winter weather in China.

In the U.S., the downward repricing of risk rapidly became a collapse as flaws in the U.S. rating agency process bobbed to the surface. With so much distressed commercial paper floating around, many people were paranoid about risk. It was like the old game of “hot potato,” except nobody could pass their potatoes onto the next guy down the line.

For example, in one major presentation, I heard General Electric CEO Jeff Immelt spend a large part of his discussion defending GE’s “triple-A credit rating.” Normally, Immelt would be up there slapping the pointer against the screen and bragging about all the great products that GE makes and sells. Instead, he was busy trying to “prove a negative,” that GE does not hold bad paper in its money operations. But Immelt believed he had to defend GE’s stock price by dispelling fears of a rating markdown.

And through it all, the resulting stock market gyrations were a reflection of investor confusion about the future. Are we at the end of something good? Are we at the beginning of something bad? Is this the beginning of the end? Or is it only the end of the beginning? Really, what comes next? Will credit markets liquefy? Or will they stay dried out? Can we do business? Or should we hold tight and sit on the cash?

Paul Krugman of The New York Times recently told Fortune , “Large parts of the financial system will have to be reinvented.” And there’s no argument from me on that one. But so much of the financial system is broken that the question is where to even start.

It is apparent that much of the old way of doing business – particularly in the realm of money lending – was rotten to the core. In my view, it begins with the U.S. dollar itself. The dollar has been steadily deteriorating in value for decades, so inflationary expectations are part of the worldwide consciousness. That is, just because of the long-term decline in the value of the dollar, most people expect most things to go up in price most of the time.

So is it any wonder that people developed a “speculation expectation”? This fed into an entitlement mentality, as well, that tainted every rung of the credit ladder. A lot of people wanted to buy and flip, whether it was houses or stocks or commodities. So money lenders gave to people to enable buying and flipping. Flipping became a dominant, if not defining, element of the financial “industry,” of sorts.

But what an industry! For example, in the past five years, many people just plain lied through their teeth on everything from credit card applications to mortgage applications to the money lending documents for multibillion-dollar takeovers. It was pure and brazen fraud in many instances, verging on burglary in plain sight. The next level up the food chain – the brokers and loan officers – often just looked the other way and rubber-stamped the papers. “Hey, not my problem.”

This kind of bad buck-passing went all the way to the top of some firms, many with familiar names. There in the ethereal reaches of the nice office buildings in Irvine, Calif., and Fort Lauderdale, Fla. – let alone Wall Street – the chief executives knew, or should have known, how risky the portfolios were becoming.

But these corporate worthies let it happen. The pressure to “make the numbers” was too much. The money was just too good. The bonuses were too sweet. And besides, there is always the old excuse that “Everybody does it this way.” Yet it was not for nothing that the ancients defined greed as a deadly sin. At each step of the ladder of financial deceit, people just let it slide. They should have known better, and maybe they did know better.

Now looking ahead, we have a hell of a rocky road before us. And can we as a society really “regulate” our way out of that situation? Or is there a systemic problem with deeper roots? Really, what do the Furies have in store for us?

Regards,

Bryon King
for The Daily Reckoning Australia

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