Harassing us!

Recall that last week, we reported the latest news on the SEC. Investigators wondered why the agency had let Madoff run billions in suspicious trades without ever checking them out. The SEC responded by saying it lacked sufficient resources. Then, New York Senator Schumer said he would propose a measure to increase the agency's spending power by 75% - by allowing it to shake down the financial industry directly, rather than going to Congress for a budget allocation.

Which still leaves open the question of what the SEC was doing when it should have been making Madoff do the perp walk. We have the answer: the SEC was harassing us.

Yes, hard to believe that they would target your poor, innocent editor. And they didn't, not directly anyway. Instead, they targeted one of our colleagues. This was a couple of years ago...when Bernie Madoff was at the top of his game.

We haven't mentioned it in this space...on the advice of our lawyer. Judges don't like it when you "try a case in public." And the case still isn't settled.

But we won't discuss the merits of the case...only the circumstances around it.

This will help us understand what the SEC is really up to...and why the hope of regulating fraud out of existence is as vain and futile as trying to clear out a bar by using foul language.

Here's what happened. One of our researchers discovered what he thought was a great investment opportunity. He called the target company and spoke to a VP in charge of public relations. What he heard convinced him that he was on to something, so he published a recommendation, sending a copy of it immediately to the company.

He got no response from the company. But a few months later, the SEC knocked on our door. What was their beef? That we had misled investors. How so? In our report, we told readers what the VP had told us. We carefully called it "insider" information...putting the word in quotes to let readers know it wasn't the same as the forbidden 'inside information.' Anyone could have found out the same thing if he had just called the company, read the published reports, and put two and two together.

Our caution was lost on the SEC. They didn't see the difference between "insider" information and inside information. What's more, the fellow at the target company denied he had said what he had said. Curiously, he made no objection when the report was published; the objection came after the SEC started snooping around.

The SEC wanted blood. They thought they could get an easy win against a little guy in Baltimore. They wanted us to turn on our own associate...to stop defending him and cop a plea. Obviously, we couldn't do that. We stood behind our man.

Then came a quirky turn of events. Both the researcher and your editor's company were charged with what was effectively a new crime - a federal case, no less. The SEC, remember, is supposed to be protecting investors from stock fraud, manipulation, and 'insider trading.' But there was never any allegation of manipulating a stock or insider trading. Instead, the agency charged us with NOT having inside information. We never traded in the stock at all...or manipulated it in any way. So the feds alleged that we did not have any inside information to trade on...and that therefore our representation - of having "insider" information (in quotes!) - was a kind of fraud.

And the whole case turned on a telephone conversation between a stock market analyst and a public relations guy in a company. One said one thing; the other said another thing. Reporters make mistakes all the time; so do their sources. But this was the first time the government made a federal case out of it.

We believe our analyst. The SEC believed the other guy and spent millions trying to prove that our fellow lied. No one who bought the research report on the stock complained, let alone threatened a lawsuit. Prior to any SEC probe, refunds were issued to anyone who asked (most did not). Yet the SEC, protector of the public interest, spent years...and millions...on the case - while Bernie Madoff was stealing billions from his clients.

Case against your editor's company: judges ruled that we were innocent.

Case against our colleague: still undecided at the appeals court.

Case against SEC: guilty of negligence, dereliction and humbug.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Madoff Astonished SEC Didn’t Verify His Claims
• Why The SEC Sued Me – And Why You Should Care
• Rising in Defense of Goldman Sachs
• Social Security a Bigger Scam Than What Bernard Madoff Schemed
• Real Estate Brokers: The Latest Victims of the Housing Crunch

Front page in The Washington Post: "The Madoff Files...A Chronicle of SEC Failure..."

According to the Post, Madoff was "astonished" that the SEC didn't bother to verify whether he was actually doing the billions of dollars worth of trades he claimed to be doing.

In response, the SEC says it "doesn't have the resources" necessary to keep an eye on "the exploding number of financial firms."

And according to today's International Herald Tribune, Senator Schumer has suggested a way for the SEC to increase its budget by 75%. The idea is to turn it into a kind of tax farmer...with the right to earn money directly from the industry it is supposed to regulate. There's an idea for you - a very bad one. It would give the SEC more money to waste...allowing it to hire more people to meddle in the marketplace...giving investors more illusions that they are playing 'on a level playing field'...and ultimately corrupting the financial sector even more than it already is.

Which brings us back to our original question: what was the SEC doing?

The Madoff group was very suspiciously doing billions in trades with remarkable profitability and consistency. Every trader in New York knew something was up. What was so intriguing to SEC eyes...when they weren't keeping their eyes on Madoff?

We can tell you. Us! Your editor and his colleagues. No kidding. We'll give you the full story next time. Promise.

Bill Bonner
for The Daily Reckoning Australia

• Who Was the SEC Harassing Instead of Madoff?
• Bernie Madoff is a Giant in His Field
• Gold Coins for $870-$890 An Ounce
• Bernie Madoff and the SEC
• The Dow Gives Up the Post-ZIRP (Zero interest rate policy) Gains

Today is the day the Fed begins buying U.S. Treasuries. Britain is doing it already. So is Japan. Why shouldn't we? What's a few trillion extra...just between friends?

The scope of the project is immense.

Do you remember how it works, dear reader? When you buy a U.S. Treasury bond, you pay for it with real money - or, at least as real as dollars get. Money changes hands. No net increase in the money supply. But when the Fed buys a Treasury bond it creates the money to buy it...and thus the money supply increases. It's called "monetizing the debt" - or converting debt into currency. Given the size of upcoming Treasury purchases, the total size of the U.S. monetary base is expected to increase 500% in the months ahead.

Is there any doubt what this will mean to the dollar? To the price of gold?

Yes, there is...

Alas, the more we learn, the less we know. The more we find out; the more we find out what we haven't found out yet.

But we'll come back to that in a moment. Let's first look at what happened on Wall Street yesterday.

Stocks went down - 115 points on the Dow. End of the rally? We keep wondering. Whatever can be said about it, it's not the best rally we've ever seen. It seems to peter out every time it gets going. But we'll wait a few days before pronouncing judgment.

Meanwhile, oil seems sluggish at $54. The euro, too, at $1.34. But gold at least showed some action - down $28 to $923.

What happened in the gold market? Didn't investors notice that the Fed has begun almost literally "printing money?" Why didn't the price go to $1,000?

But remember how we've worried that inflation was too obvious? You can see it coming a mile away. Which is why we say the United States can pay off its debts in a currency whose value it alone controls...

But what if it weren't true? What if the feds couldn't control the value of the dollar? What if inflation didn't happen - at least, not the way we all expect?

Let us begin with something that is true: that which must happen will happen.

When you increase the money supply, ceteris paribus, the price of money must go down. That is why the price of gold is over $900 rather than, say, $750. Investors see the trillions going into the world's money supply. They weren't born yesterday. They know what happens next. It is just a matter of time before the price of gold doubles...and doubles again.

But just because you add to the money supply doesn't mean prices MUST rise. Instead, it means only that that MAY rise...under certain conditions.

Ah...there's the rub...there's the crack in our little bell...there's the little grain of sand in our shoe.

The Japanese have been monetizing their debt for a long time, writes our friend James Ferguson in MoneyWeek.

"First, the authorities ran a steady double-digit growth in the money supply for over a decade, while the Japanese banks were initially in denial, and then the government injected nearly 10% of GDP directly into the banks' capital bases. Yet even after money as a proportion of GDP had doubled, Japan's banks were still shrinking lending.

"The Bank of Japan, believing it had perhaps just lacked imagination, doubled M1 money supply again, this time over the much shorter period of two to three years from 2001."

This is roughly equivalent to the Fed spending not $1 trillion to buy up Treasury paper, but $10 trillion.

"Yet the impact on Japanese bank lending was...nothing," James continues. "Bank lending continued to fall by 5%-6% a year, as it had done for the prior three years."

James lived in Japan for many years. He reports that when the Japanese economy finally began to pick up in 2006, the government became very concerned that all that money it had put into circulation would suddenly turn into consumer price inflation. But it didn't happen. Instead, the little flower of growth was crushed in the downturn of '07-'08...and now Japanese prices seem to be headed down again.

How come? Are the Japanese particularly incompetent? Or is it harder to weaken your currency than we thought?

We don't know...so we will turn to Ian for further news while we think about it...

"The housing swan dive continues today," writes Ian Mathias in today's issue of The 5 Min. Forecast.

"U.S. home prices have been reduced to levels unseen since 2003, says the latest rendition of the S&P/Case Shiller Home Price Index. Yesterday's printing capped off 2008 with another record decline.

"December data showed a 19.2% yearly fall for their 10 city composite and a 18.5% slump for the 20 city - both records. This index has now fallen every month for two straight years.

"'The broad downturn in the residential real estate market continues,' says David M. Blitzer of S&P. 'There are very few, if any, pockets of turnaround that one can see in the data. Most of the nation appears to remain on a downward path...'

"We suspect this home price trend will continue in Case Shiller's January and February reports," continues Ian. "According the National Association of Realtors today, the median new home price fell to $200,900 in February. That's a record 18% fall from the same time a year ago and the lowest level since 2003. Consider yesterday's record fall in existing home prices, and it seems this trend is still alive and kicking."

Each day, Ian and Addison bring readers the The 5 Min Forecast, is an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less.

And back to Bill, reporting from London...

It would be much simpler for us if the world were set up in a more orderly and predictable way. But then, it wouldn't be nearly as much fun. Even the feds could control a simpleton's world. What a dreary place that would be!

Still, ships' compasses don't intentionally lead us onto the rocks. More money = more inflation; that's the rule. Besides, it's not just a matter of money. The feds are clearly sowing the wind with their quantitative easing. They deserve to reap the whirlwind.

But wait...it's inflation they WANT. Nature, in her wisdom, rarely gives a rascal what he wants. Instead, she gives him what he deserves. What then, do the feds deserve? We know their crime...what will be their punishment?

Ah ha! Maybe they deserve the doldrums...locked in irons, with no wind at all!

They want to lower the debt burden by instigating inflation. They want to increase the velocity of money - by lightening it up a little so people are eager to get rid of it. They want to get lenders lending, and consumers consuming - all eager to turn over their dollars as fast as possible. They want to shift the burden of losses from the people who made them to the people who didn't. Well, what if the dollar doesn't cooperate? What if it grows heavier? What if it seems more solid? And what if dollar-denominated debts sticks like tar to the people who incurred it?

Seems impossible, doesn't it? And yet, that is what happened in the Land of Rising Sun.

Our hypothesis seemed so sure...so airtight. The feds have no alternative but to try to inflate the currency. Because it will reduce the debt load on consumers...and, not coincidentally, on the government too. It will also induce people to spend money, rather than save it. This will increase the velocity of money, which will have a further inspiring effect on animal spirits.

If at first they don't succeed, the feds will try, try again. And sooner or later, they'll get the inflation they desire - first in moderation, then in exaggeration.

But what if it doesn't happen that way? What if the feds - and the entire debtor class - were tortured before they were finally killed? And what if we - those who think we know what is going on...and who are stacking up gold coins in our home safes in anticipation - are driven mad by deep corrections in the gold market? What if gold sinks to $600...and stays there for years?

What if the markets stay irrational for longer than any of us can stay solvent...first wiping out the bulls in a major new break in the stock market...then wiping out the bears with a major new break in the gold market?

And then, when we have all given up hope...and sold all our stocks...and all our gold...and are curled up in a corner, whimpering, clutching a handful of crumpled dollar bills, maybe then Mr. Market will feel sorry for us. Maybe he'll finally come over and put us out of our misery...delivering the coup de grace of blow out inflation...a la Weimar or Harare?

Anything is possible. But there are major differences between Japan and the United States - and reasons to think that the U.S. feds might succeed where the Japanese feds failed. For the moment...we'll keep our Dollar Crash Alert flag flying...and wait until tomorrow for further insights.

"It comes as no great surprise," comments colleague Chris Mayer, "that the value of our money has done nothing but depreciate over the years."

"So what are investors to do?

"First off, buy things. In a world in which paper depreciates, tangible assets will hold their value better. Unlike with paper, we can't create oil reserves or clear land or find water by pressing a few buttons at the Fed. Tangible assets take time and labor to create.

"Secondly," Chris advises, "buy gold and gold stocks. Gold is a commodity, but it is unique in its monetary heritage. It was money - in the sense that you could buy groceries with it - not that long ago, in the grand scheme of things. People are again flocking back to gold as the dollar's prospects turn uglier. This move has a long way to go.

"Gold stocks are a more leveraged and riskier way to play the rise in gold. This year, in particular, sets up as a good one for gold, thanks to lower energy prices and currency effects.

"And finally, buy the stronger currencies or assets in stronger currencies. All paper currencies are on the long road to zero. But some are on a faster road than others."

Those are just a few of Chris' ideas. Many of the companies in the Mayer's Special Situations portfolio fall into these three 'buckets' that he outlines above - and have been performing well.

The current actions by the feds have the Chinese worried...but their worry is that the feds may succeed in debasing the dollar. Here, they're proposing a new monetary system...based on Special Drawing Rights (on gold) administered by the IMF. The country's central bank governor Zhou Xiaochuan said as much in an essay, published earlier this week:

"The outbreak of the current crisis and its spillover in the world confronted us with the long existing but still unanswered question i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF? There were various institutional arrangements in an attempt to find a solution, including the Silver Standard, the Gold Standard, the Gold Exchange Standard and the Bretton Woods system. The above issue, however, as the ongoing financial crisis demonstrates, is far from being solved, and has become even more severe due to the inherent weaknesses of the current international monetary system.

"Theoretically, an international reserve currency should first be anchored to a stable benchmark and issued according to a clear set of rules, therefore to ensure orderly supply; second, its supply should be flexible enough to allow timely adjustment according to the changing demand; third, such adjustments should be disconnected from economic conditions and sovereign interests of any single country. The acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history. The crisis called again for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability..."

Finally, so many sideshows... Madoff, AIG bonuses, Geithner...and tax havens. Here at The Daily Reckoning, we've never met a tax cut we didn't like...or a tax haven where we didn't want to have money.

But the world's governments are cracking down. They don't like it when people get away...so they're raising the walls and electrifying the windows. Tax havens are for tax cheats, they say. Tax havens are being abused, they go on.

In a better world, of course, there would be no need for open doors. People would be happy where they were. They would stay put...and turn over however much of their money to the government as its functionaries requested. But occasionally, something goes wrong. Occasionally, people are unhappy - and with very good reason. So it was that German trade unionists and Jews turned to Swiss banks in the 1930s - to protect themselves from getting robbed by the Nazi regime. The Germans asked the Swiss to divulge the names of its account holders. The Swiss said they would not. Bank secrecy was introduced in Switzerland in 1934 so that Swiss bank managers would have to reply in the negative, and the law prohibited them from revealing their clients names.

Now, of course, everything is different. All the world's governments are good. And they are all working for the benefit of their citizens...except AIG bosses, of course. Now that the rapture has arrived, we have no further need of open doors or secret bank accounts.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Chinese and the Fed Both Buying U.S. Treasury Bonds
• 4 Ways to Protect Against a Falling Dollar
• Cash is Created When the Feds “Monetize the Debt” by Buying US Treasury Bonds
• Citizens Easily Coerced into Using Government Currency
• An International Currency Not Just on Paper

No kidding. Dilapidation may be coming back into style. That's what one of Madoff's victims proposed in front of the courthouse.

We're in the "anger" stage, writes John Authers in the Financial Times. No more denial...now, people want blood.

After the South Sea Bubble blew up, in the 18th century, the Walpole government was faced with similar anger. It seized the property of the company's directors and used it to pay off the victims. Then, a resolution was proposed in Parliament by which the bankers involved in the scandal would be tied up in sacks filled with snakes and tipped into the Thames River.

So far, Congress has not proposed stoning Fannie Mae or sending AIG directors to the bottom of the Potomac. But it must be warming to the idea.

"Congress is looking for heads to cut off," says the French press.

One member of Congress - Senator Grassley - retreated from his call for AIG executives to commit suicide. It would be all right with him if they just showed a little contrition, he says now.

But all over the world - and especially in Washington DC - the mobs are out in the streets with liquor on their breath and ropes in their hands.

The proximate cause of this anger is the bonuses paid out by AIG - after the company got a taxpayer bailout of $170 billion. According to the New York Attorney General, 73 AIG execs got $1 million + bonus checks.

"Livid Democrats demand AIG return bailout bonuses," says a headline in today's financial press.

We hope you realize, dear reader, that all of this, of course, is just a cynical sideshow. It's a distraction...a self-indulgent tantrum; the real story lies elsewhere...which we'll come to in a minute.

First, the rally is still going on. Stocks have recovered about 10% of their losses so far. And yesterday, the Dow rose another 178 points.

Don't forget, this is not a new bull market. It is a bear trap...a rebound in an on-going bear market. After this phase of anger passes...people will probably feel that the worst is behind us. They'll squint and see a "light at the end of the tunnel." Later on, they'll realize that the light is an on-coming freight train!

Yesterday's up-move was traced to a surprising report from the housing industry.

"Housing starts unexpectedly increase on condos," explains a Bloomberg headline.

And today, the Fed meets. Analysts are betting that the Fed will begin more "massive buying" of assets - especially U.S. Treasury bonds - in order to get more money into the system.

All the news is not favorable, of course. Auto loan delinquency rates are running 9% ahead of last year. Thornburg Mortgage is apparently headed towards Chapter 11. Caterpillar says it will lay off more than 2,000 workers; less construction means less need for heavy equipment. And AMEX says even its best customers are falling behind on their bills.

But let's go back to into the theatre and take our seats: The politicians give money to their pet projects...and then pretend to be outraged when the companies use it to pay their bills. Among their bills were billions in payments to other companies -notably Goldman Sachs, former employer and major source of wealth for the man who designed the bailout, Hank Paulson - and thousands of employment contracts with AIG's salarymen.

What did the feds think when they gave AIG the money? That they were donating to charity?

No, dear reader...the fix was in. And it's still in. And while the press and politicians huff about a few million in bonuses to AIG's hacks, billions more is being paid out to AIG's counterparties.

It's not only a waste of money, says our old friend Jim Rogers, the bailouts actually retard a recovery. How so? In the obvious way. Like any kind of subsidy or welfare payment, they invite people to keep doing what they've been doing - no matter how unproductive it is. Instead of letting AIG and its bosses and counterparties go broke, the feds give the whole brain-dead system a transfusion of taxpayers' money. So the executives don't have to go out and find other work. And AIG can continue peddling its mortgage insurance. And its counterparties, too, are protected from their mistakes.

Of course, the government doesn't want to raise taxes in order to keep these incompetents in business, so it bleeds the money from the next generation of taxpayers - who aren't around to protest. Instead of letting the debt be reduced by the natural process of deflationary default, in other words, the government adds more debt.

Already, as we pointed out yesterday, there's about $20 trillion worth of debt debris that must be brushed aside before the economy can begin rebuilding on a solid foundation. At the present rate of savings, it will take about 45 years to do the job. Which suggests to us that it ain't gonna happen. We don't think the feds can sit still that long. And they're not sitting still now. In fact, they're adding to the public debt faster than the private debt is getting paid down.

By our calculations, the private economy is paying off about $420 billion - net - per year. (Just based on higher rates of saving...not counting write-downs, and defaults.) But the federal deficit is expected to run to $2 trillion! In other words, the feds are adding debt 4 times faster than the private sector is paying it down.

This is not a formula for putting this problem behind us. Instead, it just pushes it ahead.

Now, we turn to Baltimore, to see what Addison has for us...

"'We do want foreign capital to come in here and we want private capital,' our favorite stammering Rep, Barney Frank said yesterday.

"After emerging from a House Financial Services Committee meeting," writes Addison in today's issue of The 5 Min. Forecast, "Frank found a few mics to spit into... and the off the cuff pontifications proffered fourth. This was our favorite:

"'We just had the Chinese raising the specter of not buying our Treasuries. Well, that would be troubling. I think they're bluffing, personally.'

"Ha!

"Bluffing? We thought bluffing meant you were acting strong despite a lousy hand... like this:

"This game is played with the cards up...and China's holding all aces."

Addison writes every day for The 5 Min Forecast, an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments -- in five minutes or less.

Back to Bill, in the land of wine and cheese...

Newsweek magazine offers bad advice: "Stop Saving Now!"

We didn't read the magazine's account; giving the editors the benefit of the doubt, we will guess they were being ironic.

All over the nation - and perhaps the world - people are cutting back, making do, and doing without. "Frugal families doing own chores," says one headline. "Beat the recession by growing your own vegetables," says another. And a popular new website, called Mint.com, is a runaway success; it helps people plan their budgets and find ways to spend less money.

All of this financial rectitude is having a deleterious effect on the economy. The old economists called it the 'paradox of thrift.' The man who plants his own vegetables spends less with the green grocer. Then, the grocer spends less with his suppliers. Then the suppliers spend less with their suppliers. And so forth. Soon, everyone is spending less money...and you have a depression.

So, a civic-minded reader might think he should step up his shopping - if he were an idiot. He might think we'd all be better off if he spent more money...and everyone else did the same.

But that's not how it works. We're not all better off when we all do something stupid. We're only better off when we all do something smart. And when people have spent too much money - and gone too far into debt - the smart thing to do is to spend less, not more.

*** Income-on-Demand's Wayne Burritt on last week's market bounce:

"As you can see from this chart of the S&P 500 - a good gauge of the broader U.S. stock market - last week's bounce has ignited a mini-rally that is just plain joy to see. In fact, from a low last Monday, the S&P 500 has surged a mind-blowing 15%. Wow!"

"Even better: The market's latest action snapped a series of down days that had just about everyone running ragged, me included.

"The market also bounced on higher volume, another big plus for a straightforward reason: When up-market moves are accompanied by higher- than-average volume, it's a clear sign that bullish investors are attracted by the positive market action and are willing to buy shares to prove it.

"But that's not all. Last week's bounce was not just a big volume day: It was the highest-volume day out of the previous seven trading days. I have to go all the way back to the bounce of late November to find a similar surge in buying volume.

"Significant? You bet. When the market bounced late last November, it immediately began a run that didn't end until the S&P 500 hit 944 on Jan. 6 of this year. From the November low of 741, that run marked a massive 203-point surge.

"Translation: A bounce similar to last week's ushered in a whopping 27% upside bullish run on the S&P 500 just a few months ago. Given that we've moved 15% in just a matter of days, this run could best last November's by a long shot.

"Now, I'm not about to say that it's time to pop open the champagne. But facts are facts, and current market action is certainly a step in the right direction."

That's going to do it for us today. Keep reading for today's guest essay from Bill Jenkins who will explain how he sees signs of socialism more and more in today's headlines.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Feds Think They Have Won This Fight Against the Depression
• Bear Market Bounce a Sure Thing
• The Outrage Over AIG and Their Bailout Money
• Investors’ Objective: To Make Money
• Reader Comments About Our Upcoming Gift to Congress

ld fell below $900. The yellow metal still looks good. It is at an all-time high in terms of the euro and the pound. But it still has a long way to go.

Gold is the thing you buy when you suspect that monetary authorities are making a mess of things. The fixers are fixing more than ever before. What are the odds that some of the fixes go bad? We don't know...but our guess is that gold is looking forward to it.

Meanwhile, consumer confidence in the United States is at an all-time low. Fannie and Freddie say they need another $51 billion. Dow Chemical is considering cutting its dividend for the first time since 1912.

Everybody likes the wages of sin...until the devil calls...

This week began with a squabble. John Thain was sacked as head of Merrill Lynch after giving out $4 billion in bonuses - just before announcing $15 billion in losses for the 4th quarter of '08. The Bank of America, Merrill's new owner, said it hadn't approved the bonuses. Thain said it had been 'informed.'

Then Citigroup announced that it had bought a new corporate jet for $50 million. Seemed a bit rich for a company that had just lost $8.3 billion.

What sort of devilry is this? Where can you can lose billions...take billions in handouts from taxpayers... and still coddle executives with new planes and million-dollar 'bonuses?' Penalties would seem to be more appropriate.

By Tuesday, President Obama was already expressing the outrage of the public; he announced that if banks were going to take money from the public, they would have to limit executive compensations and dividend payouts. He pledged to impose "tough and transparent conditions on firms receiving taxpayers' assistance." Bummer. The party's over.

But it was fun while it lasted. When animal spirits run high, the animals in the financial industry are able to make a buck. Nothing very surprising about that. But the amounts were startling. At Goldman Sachs, for example, the average compensation in 2006 was $521,000 - including secretaries and cleaning staff. Henry Paulson, then CEO of Goldman, later Secretary of the Treasury, earned $38 million.

But it was not just financial industry workers who were getting rich... In the Bubble Epoque, the entire upper crust was glazed with honey. In 1970, top American CEOs made about 39 times as much as the average employee. Thirty years later, the average pay had risen to $37.5 million... nearly 1,000 times higher than the average worker's paycheck.

Part of the reason for this explosion of avarice can be traced to the government's own attempts to limit it. In 1993, Congress limited the tax deductibility of executive salaries to $1 million - except where compensation was tied to performance. This left corporate compensation boards to shift more to the use of stock incentives, based on targets and benchmarks, which were hard to argue with. CEO's pay increase almost 300% between 1990 to 2005, while production worker's wages rose only 4.3%. And during that same period CEO's pay rose twice as fast as the S&P...and three times as fast as corporate profits. Soon, every manager wanted a 'piece of the upside.' Investors could have the downside all to themselves!

Like Bernie Madoff, the CEOs put it over on everyone - the capitalists as well as the proles. The poor working stiffs had foreign labor breathing down their necks. If they got out of line, their employers would export their jobs to China. The patsy stockholders had no chance either. They knew perfectly well that the schmuck running the business wasn't worth what he was being paid, but who could argue with "performance?" Besides they had "compensation committees" and consultants to tell them is was "reasonable" or competitive.

Retired CEO of DuPont, Edgar S. Woolard, Jr., did. In 2005, he was chairman of the NYSE's executive compensation committee. As to the need to pay such high compensation in order to get good talent, he replied with a single word: "bull." But did not the super-paid super-CEOs create super wealth? It was a "joke," said he. He blew the whistle. But no one came a running.

Our own experience in business tells us that the larger the corporation gets the less important the CEO becomes. Many become nothing more than mouthpieces, ambassadors and cheerleaders for businesses they barely understand. They do not 'run' the business; the business runs them.

And the evidence of the last few years tells us that the only thing these super CEOs were good at was negotiating their own compensation packages.

Public records tell us that Jimmy Cayne, once CEO of Bear Stearns, once a leading Wall Street investment bank, spent about a third of the month of July, 2007, playing in various bridge tournaments. You might expect that a man who was paid nearly $3 million per month for his services would be on-call 24/7. At least, you might expect him to come into the shop when the firm ran into trouble. But July 2007 was the month Bear Stearns went broke.

Dick Fuld made nearly $4 million a month in his last year at Lehman Bros. At $25,000 an hour, you'd expect him to keep his eye on the ball. Remember too, this was the firm that had survived the Civil War and the Great Depression. But Fuld seemed to have no idea of what was going on. In the end, he blamed short sellers - as if he'd spent a career on Wall Street and learned nothing about how it worked.

Short sellers can't bring down a large, healthy firm. But when they see a Humpty Dumpty like Lehman on the wall, they give him a push.

*** When there is a financial boom, capital assets throw off capital income - capital gains, dividends, interest and rent. When executives cash in their stock options, for example, they get capital income. From 1979 to 1993, the top one percent of households earned about 40% of all income from capital. But in the bubble years, the amount shot up to nearly 60%.

The envy crowd moaned and complained. But why shouldn't the capitalists get a bigger share of the pie? And then, when the pie suddenly goes bad...why shouldn't they be the ones to get indigestion?

*** Harry Markopolos sent a 17-page letter to the SEC on November 7, 2005, write Michael Lewis and David Einhorn in the New York Times . He was blowing the whistle on Bernie Madoff. He explained to the regulators why Madoff's firm couldn't be on the level. He wasn't 100% sure what Madoff was up to, he hadn't been able to look at the books, but he had been in the investment business long enough to smell a skunk. It was mathematically impossible for Madoff to be doing what he said he was doing. Most likely, he wrote, "Madoff Securities is the world's largest Ponzi Scheme."

He was right. But who cared?

Not the customers. According to a Bloomberg article, "Madoff enablers winked at suspect front-running." Many investors in Madoff's accounts thought something funny was going on. They believed that Madoff was ripping off his retail clients by front-running their purchases and sales in order to deliver steady, above-market returns to his managed accounts. But nobody is easier to scam than a scammer. His managed account clients were perfectly happy to go along with the scam...as long as they thought they were on the receiving end of it.

The SEC didn't seem to care either. With Markopolos's letter in their hands - not to mention many phone calls over a several-year period - SEC regulators saw no evil, heard no evil, nor spoke no evil of Bernie Madoff.

And now the folks at Davos are talking about creating a "super SEC" that will regulate the whole world. What can we say? The bigger the fix...the bigger the fool.

*** Tomorrow...an interview with the man of the hour...Gideon Gono! For the record, here at The Daily Reckoning, we don't believe in Keynesian or Monetarism or practically any other ism we can think of. But we have confidence in Gonoism. If you really want to destroy an economy...and a currency... yes we can!...Gonoism works.

Bill Bonner
for The Daily Reckoning Australia

• Bernie Madoff and the SEC
• Gold Coins for $870-$890 An Ounce
• The Baddest Bank in the West
• The Country is Going into a Recession with its Finances in the Worst Shape Ever
• Madoff Astonished SEC Didn’t Verify His Claims

Today, we're going to give the feds some advice. Many will find our advice repulsive. Others will find it shocking. Still others will think we are joking.

True, the feds haven't asked our advice. And true, people will ice skate in Hell before they take it. But at least we will feel that we have done our duty. Besides, to them that give much is given. Something like that. It's in the Bible.

Follow the trail of our advice to others...and we will get something for ourselves. What we will find is a fuller understanding of the economic big picture...and perhaps a better sense of how to protect ourselves.

We begin, however, with the latest reports from Wall Street.

The Dow fell again yesterday. It's down to 8,474. Oil and gold are still going down too. Yesterday, oil slid to $37 and gold lost $34.

Meanwhile, unemployment in the highest it's been in 16 years - and rising. At 7.2% in December, it is probably already 8% now. USA Today reports that men are losing jobs more than women. This is probably because the damage in autos, finance and construction, industries dominated by men, has been so great.

But you think you've got trouble? What unemployed Americans don't buy unemployed Chinese don't make. A report at Bloomberg tells us that 10 million migrant workers in China lost their jobs in the first 11 months of 2008. By now, the figure is surely much higher.

"Poverty does cause violence," says a professor at Columbia who studied the issue. The Chinese government has warned that it may be faced with "mass incidents" in which it has to use force to keep the mob under control. Next door, Russia has already called out troops to put down a tax revolt in Siberia.

"I'm getting a license to carry a handgun," said an American friend, surprising us over dinner last week. "I don't know...but I see people getting desperate."

Elsewhere in the news is a report that shoplifting in the United States is rising. More than 80% of stores surveyed said it was becoming a bigger problem.

And in Spain, people are so desperate for work they're joining the army. When the market declines, politics - especially armed politics - increases. Like Ireland, Spain profited in a big way from the boom in credit. But now that the boom is over, it is suffering in a big way too. House prices are slumping and jobs are disappearing. Our team in Buenos Aires - which keeps an eye on the Spanish-speaking world - tells us that only 47,000 young men signed up for military service in 2007. In 2008, the total rose to 80,000. According to some experts, by 2010, one out of every five Spaniards in the work force will be out of a job.

The IMF says it may need another $150 billion to fight the worldwide slowdown. Chickenfeed, really. This thing has gotten so big, $150 billion won't even be noticed.

The World Bank says global trade is shrinking - for the first time in 25 years. And here, is where we pick up the trail. With so many clues...so much data - so much noise! - it's easy to get lost. But here we have a lead we can work with. Let us begin here.

World trade is shrinking. Across borders, at least, people are buying and selling less. Why would they do that?

We were afraid you would ask that. Because the answer requires more time than we have this morning. So we will simplify. Economies naturally expand and naturally contract. In an expansion, world trade increases. In a contraction, it diminishes. Typically, the big increases in global trade correspond with the rise of imperial powers - armed forces large enough to protect trade routes...guarantee the safety of merchants...and enforce a uniform, reliable commercial code. Trade expanded greatly during the Roman Empire...then contracted sharply when it fell. The Mongol Empire too created a huge free trade area in Eurasia. Then, the British and other European powers expanded their sphere trade along the shipping lanes...throughout most of the world...until they were rolled back from much of Eurasia by the advance of other hostile empires - the Soviet Union and China.

The last major boom in world trade came with the Reagan Administration. The free-marketers in the '80s - both in England and America - lowered taxes and reduced barriers to commerce. Then, a remarkable thing happened - the Soviet Union collapsed, leaving its member states and client countries free to enter into trade with the West. China also realized that its rice bowl would be fuller if it too began selling to the West, rather than threatening it.

That Golden Age of ebullient world trade is now over. It could, of course, be nothing more than a temporary setback to system of imperial finance that is otherwise in good shape - a mere runny nose and sore throat...nothing to worry about. But the noise we hear sounds more like a death rattle than a head cold.

But the quacks are at work, busily making the situation worse.

Looking at the essentials of the economic situation, we see it in 3D:

A natural Deflation of asset prices in the financial world...

...leading to a natural Depression in the economic world....

...with an army of public officials Determined to turn things around.

Their approach is the old 'hair of the dog that bit him' technique. The world has had too much credit; they propose to give it even more. With $10 trillion in "stimulus" efforts all over the planet, they're not giving only a hair of the dog; they're throwing in the whole damned kennel.

These efforts are not going to work. Why not? Because you can't help an obese man by giving him another helping of dessert. And you can't cure an alcoholic by offering him free drinks.

If the feds were paying attention, they should listen up here:

The cure for a slump is a slump.

A real correction corrects. Cold turkey. Rehab. Debts are paid off, worked off, or written off. Prices fall to the point where they make sense again. Consumer items become affordable; an ordinary person can buy a house. An ordinary investor can buy a stock...or an apartment building...and get a decent return on his money. An ordinary businessman can make a profit from operations; he doesn't have to count on stock options and rising share prices in order to make a living.

The way to cure a correction, we repeat, is to let it do its work. But that's not going to happen. We'll explain why it won't happen tomorrow. Today, let's continue to look at what will happen - more quack cures!

Our colleagues in London tell us that the English are proposing to "tax savings to force people to spend or invest, rather than just sit on their money." That's right, they want to stimulate world trade by forcing consumers to buy more tennis shoes from India. If they don't, they'll have to pay a tax!

Another wonder drug was proposed by two former Bank of England economists. They want the government to buy houses that go into foreclosure and then rent them back to the people who couldn't pay their mortgages.

One thing you can count on, dear reader: you'll hear about plenty more schemes to correct the correction. Many of them will get the backing of the government.

And all of them will cost money - big money.

Once a bubble in one sector has burst, you can't re-inflate it. All you can do is to inflate other bubbles. After the bubble in the tech sector popped in 2000, for example, the feds manned the pumps. But they couldn't get the tech stocks re-inflated. The NASDAQ never recovered. Instead, they pumped up a huge bubble in private debt - with gassy bulges in housing, finance, commodities, emerging markets and many other sectors. Now, that bubble has burst and the feds are, once again, pumping harder than ever. This time, they're blowing up the biggest bubble in PUBLIC debt the world has ever seen.

Even Le Monde has noticed:

"The governments of the entire world are beginning to create mountains of debts in order to finance their bailout plans, their stimulus programs and their budget deficits caused by the recession. Even so, the rate at which the US and European countries borrow on the financial markets is near the lowest in history. It is only barely above 2% for 10-year loans to America and slipped under 3% for the German equivalent at the end of 2008... Some economists ask themselves if a bubble in government debt isn't in the process of forming...and they ask themselves what will happen when it eventually explodes..."

We think we know what happens. The whole system of imperial finance gets flattened.

But at least if they're going to do the wrong thing, you might as well do it well. It is a documented fact that neither the present U.S. Secretary of the Treasury - Hank Paulson - nor the incoming man - Tim Geithner - had a clue about what was happening last year. They didn't seem to understand how America's system of imperial finance - the system that undergirded expanding world trade - actually worked. They seemed completely surprised when it began to crash. Clearly, neither is competent to manage such a system.

So we have a suggestion. Why not turn to a man who does know? In all the world, there is one man who has proven that he knows better than anyone, not only how it works...but how to work.

That man is Bernie Madoff. Instead of putting him in jail, put him at the Treasury.

That is our advice for today. For it, we expect neither compensation nor thanks. But in the spirit of public service, we will explain - tomorrow - why Mr. Madoff is the man for the job.

Bill Bonner
for The Daily Reckoning Australia

• The Chinese and the Fed Both Buying U.S. Treasury Bonds
• Bernie Madoff and the SEC
• China Reduces Holdings of Treasury Securities
• Gold Doesn’t Always Need Inflation to Rise
• Bernie Madoff is a Giant in His Field