The truth is that the government's Social Security guarantee is one huge unfunded promise. How can this be? I have mentioned the Social Security "trust funds," where our payroll taxes go. All this money is transmitted to the federal government and credited to the Social Security trust funds. You would logically assume that these funds would have hard assets that have been saved and invested to cover the program's future costs. However, rather than saving the money and investing it in a diversified pool of real and readily marketable assets, the government spends it and provides "special-issue" government securities in return.

Just consider what actually goes into those funds. First there are the numbers reported in government financial statements. According to those numbers, Washington had issued approximately $2.4 trillion in special-issue US government securities that had been credited to the Social Security trust fund as of January 1, 2009. The computer records documenting these securities are held in a locked file cabinet in West Virginia. But there is a reason they are called special-issue securities, and it's not good. Unlike regular government bonds, which people like us and the Chinese government can buy, these special-issue bonds cannot be sold; in other words, they are government IOUs that the government has issued to itself, to be paid back later - with interest. Imagine if you or I could sit around writing IOUs to ourselves that were worth something. Great way to make a living.

Washington says that we can count on these bonds because they are backed by the full faith and credit of the United States government, which guarantees both principal and interest. But - believe it or not - under current federal accounting principles, the government does not consider these bonds to be liabilities - which is another way of saying the government doesn't really think that it's our money.

Think about that for a minute. If you or I lend the government money by buying a bond, the government has to pay us back with interest. In other words, that bond is a government liability. But when it comes to the Social Security trust funds, the government is saying the special-issue securities it deposits are not a liability - in other words, they're basically worth nothing at all. Now get this: The trust funds report these securities as assets on the annual reports that they provide to the public. Does that sound like wanting to have your cake and eat it too? Con artists of the world, I hope you're taking notes.

In my view, these bonds should be treated as liabilities, and their value should be counted as part of our debt-to-GDP ratio. After all, they are backed by the full faith and credit of the federal government, and I do not believe the federal government will default on them.

Under the current scheme, the Social Security program has been running large surpluses since the reforms of 1983. But in actuality, Washington has spent those surpluses every year on other government activities. That is one way the government can reduce its public borrowing and keep interest rates down.

To say the least, the federal government's accounting for these funds understates both its total liabilities and its annual operating deficits. That brings us to another clever bit of Washington wordsmithing: the "unified deficit." In public reporting, the government takes the real operating deficit, $638 billion in fiscal 2008, and subtracts the nonexistent amount credited to the Social Security trust funds, $183 billion in fiscal 2008. This "unified" figure - $455 billion - makes the federal budget deficit seem smaller than it actually is. And they have been doing this for many years.

These accounting tricks would never be allowed in the real world, where trust funds are subject to stringent accounting rules and fiduciary standards. In essence, Washington is playing a massive con game - collecting your Social Security taxes, spending that money for its own purposes, and accounting for it in trust funds that are largely a fiction. A more proper description would be "trust-the-government funds." Or as my boss, Pete Peterson, would say, "You can't trust them, and they aren't funded." Just another example of how words used in Washington don't have the same meaning they have in Webster's dictionary.

Don't worry, the reforms of the 1980s are still keeping the system above water. Monthly benefits should be paid in full for at least another three decades. However, the Social Security program will begin to pay out more than it takes in much sooner than that. The retirement and survivors income program expects its payments to exceed its revenues in 2010 and 2011. That will happen because revenue has declined during the recession - while at the same time, more people are retiring. When the federal government has to start cashing in the special-issue securities in the trust funds in order to pay benefits, it will have to raise taxes, cut benefits, and/or sell real bonds to the public in order to raise real money for retirees receiving benefits. If the government issues more public debt - in part to attract more foreign investors - that will likely increase our foreign dependency.

Regards,

David Walker
for The Daily Reckoning Australia

• Social Security a Bigger Scam Than What Bernard Madoff Schemed
• Baby Boomers Are Ill-Prepared for Retirement
• America, An Empire You Can Trust?
• China’s Economy is Now Freer and More Competitive than the United States
• Financial Difficulties Facing Social Security and Medicare Pose Serious Challenges

And don't forget the foreclosures. They're running 23% ahead of last year...even though they weren't as bad last month as last month.

Associated Press:

"The number of households caught up in the foreclosure crisis rose more than 5 percent from summer to fall as a federal effort to assist struggling borrowers was overwhelmed by a flood of defaults among people who lost their jobs.

"The foreclosure crisis affected nearly 938,000 properties in the July- September quarter, compared with about 890,000 in the prior three months, according to a report released Thursday by RealtyTrac Inc. That puts foreclosure-related filings on a pace to hit about 3.5 million this year, up from more than 2.3 million last year."

What an economy!

The Dow is now back over the 10,000 mark...just where it was in March 1999 - 10 years ago. Is that progress...or what?

During that time, the dollar has lost about a quarter of its purchasing power. That means stock market investors have lost only about 25% or their money over the decade. Not too bad, huh?

And, oh yes...they've lost their jobs too...

AP continues:

"Unemployment is the main reason homeowners are falling into trouble. While the economy is likely out of recession, the unemployment rate - now at a 26-year high of 9.8 percent - isn't expected to peak until the middle of next year."

But hey...we're not going to complain. We've got a job - trying to figure out what is going on. And that is a job that is recession-proof. Everyone wants to know what will happen next. When times turn tough they want to know even more.

So, will someone please tell us what is going on...we want to know too!

"What do you think?" asked a friend at dinner last night. "The way I see it, Obama's goose is cooked. He's stuck. He can't go forward and he can't back up. He can't back away from all those promises - including his promise to rescue the US economy. If he does, the voters and his own party will revolt. On the other hand, he doesn't have the money to go forward. He has to borrow it. And if tries to borrow much more, the Chinese will revolt.

"His only hope is that the economy revives...so he doesn't have to do anything. And that's not going to happen."

Why not? Wait a minute...you already know the answer to that question. Because it's a depression. It's the end of the road for the consumer credit economy. Consumers did their best. They borrowed as much as they could. They spent like there was no tomorrow.

But now, it IS tomorrow. And now, they've got to settle up. So, boo hoo...no more wild parties. Daddy took the T-bird away. Get over it.

What should Obama have done? Nothing. But the last chief of state to do that in a time of financial crisis was Warren G. Harding - one of America's best presidents. That's what he did in the panic of 1920. How come we don't hear much about the crisis of 1920?

Because Harding didn't do anything; it went away.

But that was a long time ago. Now, presidents are expected to do something. They have too many people around them who stand to make a buck out of it.

Yesterday, Goldman announced its quarterly earnings. Goldman, you'll recall, is the firm that former Treasury Secretary Henry Paulson (a former Goldman chairman) called 13 times before breakfast during the financial crisis of last September. And Goldman is also the firm with its men in key posts in Washington, helping the feds figure out what to do with trillions of dollars in bailout funds (TARP, TALF, Fed's buying toxic assets, etc.)

Well, what a coincidence...now the firm says its latest profit is four times what it was a year ago.

The firm's "activities have become more profitable after the crisis reduced competition and governments injected funds in the banking system," says The Financial Times.

Goldman can borrow the funds at almost no cost. Then, it can use the money in a variety of ways...such as lending it back to the government for guaranteed profits...or speculating on oil or gold, or whatever. Not for nothing is gold is up 17% in the last six months. If you can borrow at zero cost you can do a lot of speculating. Many speculators are using the government's money to bet against the US dollar - and making a lot of money.

The US government has put $13 trillion of the nation's money and credit on the line. That's how much the feds have at risk on all their toxic asset purchases, loans and guarantees. Apparently, Goldman gets its share.

What can the feds do? Everyone is telling Mr. Obama that he must do something...now! So what does he do? Something stupid, of course.

Yesterday, poor Mr. Obama did something stupid. He said he wanted to send 78 million American seniors a check for $250 each.

What a nice Christmas present. But wait. Even Santa doesn't have that kind of money. The feds are already running a deficit somewhere close to $15 billion PER DAY.

But heck, who keeps track of these things? And who quibbles about a few billion more or less?

Not us. Not here at The Daily Reckoning. We've got other things to quibble about. In fact, we've got so many things to quibble about we hardly know where to start.

So let's just pick a news item at random and we'll begin our quibbling there. Here's one:

Social Security recipients are not going to get a COLA. A COLA is a "cost of living adjustment." It's what Social Security recipients get when prices go up. It adjusts their payments to inflation.

COLA seemed like a fair idea when it was put in place. That was when prices were going up. The old folks were getting a raw deal and people felt bad about it. We remember those years. There was a report in the press in the late '70s that old people were "forced to eat dog food" to survive. We suggested that the government allow people to use food stamps to get pet food. But that was greeted like so many of our attempts to be helpful.

The trouble with the COLA is that there is no UN-COLA. When prices fall, there's no way to get the money back. The adjustments only go in one direction.

And prices ARE falling. US import prices roes only 0.1% last month...down 12% from a year ago. Take out energy and they're still down 4%. And that's with a dollar that is losing value at the same time. Imports should be going up in price. Instead, the downward tug of deflation is so strong that they are pulled down...even with the dollar buoying them up.

So, imagine that the United States slips into a Japan-like slump...a long slump with off-and-on falling prices. The government's budget projections call for a rapid return to growth. Even then, they expect trillion-dollar deficits until the end of the next decade. But if the economy does not return to rapid growth, the situation gets much worse - fast. Tax revenues don't go up...and spending continues to mount. There's no way to reduce payments to Social Security recipients. And imagine the poor sap who proposes it. Or who suggests that maybe government salaries don't have to be twice as high as private salaries. He wouldn't last long.

This leaves the feds in a tight spot. They won't have trillion-dollar deficits...they will have multi-trillion-dollar deficits. They won't have just a little trillion-dollar hole to fill; they will have a Grand Canyon.

How to fill it?

Ain't no way... Ain't no way... At a certain, but unknown, point the whole thing falls apart. The feds can't raise enough money. They go broke.

Now, hold on...the US federal government can't go broke, can it? Those fellows have a printing press. They can print their way out, no?

A very, very good question. Why would a government with the power to create money at will ever go bust? And yet, they do. Why? Because it is cheaper.

But this is far too large and important a subject for a Friday. This is a subject for a Tuesday. Maybe even a Wednesday. But Friday? Nope. God didn't make Fridays for this kind of thing. We'll have to come back to it next week.

Can anything stop the Chinese?

"China consolidates its lead in world trade," was a headline in The New York Times earlier this week.

China competes on price - and usually wins. America loses market share.

"We're finished," said our dinner companion last night. "We're fossils. We're yesterday's news. We're a nation of old people. The growth and innovation is taking place elsewhere - such as in China. You can feel the difference when you go there. New buildings. New roads. New cities. New shoppers. Here, everything is old. The buildings. The people. Everything.

"I tell my children to move to the Far East. We're history here."

This morning comes news that the Chinese have bought another auto company - Britain's van maker, LDV. And over on page 11 of The Wall Street Journal is a photo of the head of China's big bank, CCB. Asked about whether the bank was looking at acquisitions in the West, Mr. Guo Shuquing said he wasn't interested. Western banks are on a "downhill path," he said.

"Of course, there's something nice about living in a society which has peaked out," our friend continued. "You have all the grace and style of an advanced civilization without the annoying hustle and bustle. It's perfect for retired people...We live in a retirement society."

Bill Bonner
for The Daily Reckoning Australia

• Fed Made More Money than Goldman Sachs
• US Economy is Some 11 Million Jobs Short of Full Employment
• Feds Have Economy on Life Support
• China’s Economy is Now Freer and More Competitive than the United States
• Have the Feds Given the Economy a Miracle Drug?

Know what that means? It means the "Age of Thrift" is here...and that consumers really are cutting back - just like we said they would.

And it means that the consumer economy is not going to return to robust growth anytime soon. And it means, too, that people will find it hard to find jobs for a very long time.

Another thing it means is that housing prices are not likely to recover - not in our lifetimes. That was a once-a-century bubble and it has blown up.

Mortgage lenders say they expect the peak in foreclosures to come about a year from now. As for the bottom of price declines, you can expect that in 2013 or beyond. A housing bubble typically takes prices down for six years, says a study by professors Reinhart and Rogoff. But this was not a typical bubble; it was an extraordinary bubble. Seems logical that the correction will be extraordinarily deep and long too.

And it also means that this stock market rally is very vulnerable. The stock market and the economy seem to be reading different newspapers!

The Dow fell 14 points yesterday. It could begin a major drop any day. That's why our 'Crash Alert' flag is flying from our London headquarters.

Yesterday, we reported the curious fact that consumer spending as a percentage of the GDP had increased. But it only increased because the other parts of the GDP - notably business spending and investment - fell off even faster.

With output falling...sales falling...and investment (in new plant and equipment) falling even faster...who's going to hire new workers? Not many companies. And which companies are going to invest in young workers...who will have to be trained - sometimes over a period of many years - before they are really productive? Not many.

It's the "Lost Generation," says BusinessWeek. Unemployment nationwide is officially 9.8%. But for young people the rate is nearly twice that level - at 18%.

Their elders aren't doing so well either.

"Baby boomers working longer hours, for less," says a Financial Times headline. What do you expect? Their currency is going down in value. Their customers are disappearing. Their retirement savings disappeared with housing prices. They can't even borrow money anymore.

David Rosenberg:

"Now that lenders have started to respond to their record-high delinquency rates by rationing credit, a mad scramble for cash is occurring to replace the loans - food stamp usage is up 22% year-over- year, pawn shop business is up nearly 40%, and there is a tidal wave of applications for Social Security disability benefits that are not explained alone by workplace mishaps."

Boomers have no choice. They need money. So they work harder, and longer. And they get paid less. Why? Because prices are falling. Even the price of labor. It's a deflationary world.

Meanwhile, The New York Times reports, "China consolidates its lead in global trade."

This headline is a little like the announcement that consumer spending is a bigger part of the economy. It might lead you to think that global trade is growing - or, at least that the Chinese part of global trade is growing. Not at all! Global trade is still shrinking. Chinese exports too. It's just that China's part of the global marketplace is increasing...because America and Europe are losing market share. China is gaining market share because it competes on price. And price competition is what is driving this market.

No discount? No sale!

Power and wealth are shifting east. No doubt about it. The Chinese took over the Hummer this week. And they are even building a 'big plane' - the C919 - to compete against Boeing and Airbus.

Is there any business they can't compete in? We don't know...but we're counting on them to stay out of financial publishing at least until we retire!

Bill Bonner
for The Daily Reckoning Australia

• If Americans Do Not Return to Work, There Is No Recovery
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• No Way Today’s Economy is Going Back to What it Was Pre-2007
• Stock Prices Down Signals Bears to Hold onto Cash, Treasuries and Gold
• Economy Has to Grow at 1% to Stay Even With Population Growth

Today is a big day in China...it marks the 60th anniversary of the communist victory. "The Chinese people have stood up," said Mao, announcing the victory in 1949.

Then, over the next two decades, whenever the Chinese stood up...Mao shot them down himself. Mao's long march to power was a huge setback for human political progress - if there is any. The man was a thorough scoundrel and a complete incompetent at everything, except getting power and holding onto it. Every program was a disaster. When he set out to 'liberate' the masses, they ended up as slaves. When he set out to feed them, they starved. When he proposed to empower them with his "democratic dictatorship," they ended up with bullets in the back of the head.

But 60 years later, the commies are still in power. China is still red.

And yet, thanks to the curious way the world turns, China's economy is now freer and more competitive in many ways than the United States. Go figure.

As economies age, more and more people become 'rentiers.' That is, they get some special privilege...some inside angle...some conniving advantage. The latest numbers, for example, tell us that almost half of all households pay no federal taxes. They collect benefits - jobless benefits, food stamps, education, day care, Medicare, Social Security - without contributing to the system that provides them. Add to this number the millions of households that pay taxes but receive a large part of their money from the government itself - employees, contractors, lobbyists, etc. - and you have enough to win any election in the country.

But the welfare chiselers and food stamp cheats are small time crooks. The big crooks go for billions. John Crudele in The New York Post:

"...Sept. 18, 2008 [US Secretary of the Treasury...Henry] Paulson placed his first call of the day at 6:55 a.m., to Lloyd Blankfein, who succeeded Paulson as CEO of Goldman. It's unclear whether the two connected because Blankfein called Paulson minutes later.

"And then Blankfein placed another call to Paulson at 7:05 a.m. for what looks like a 10-minute conversation.

"After that Paulson called Christopher Cox, Securities & Exchange Commission Chairman twice; British Chancellor Alistair Darling and New York Federal Reserve head (and now Treasury Secretary) Tim Geithner two times.

"Then Paulson took another call from Goldman's Blankfein.

"It wasn't even 9 a.m. yet - 30 minutes before the stock market was to open - and Paulson and Blankfein had already exchanged three phone calls."

It pays to have friends in high places. That was the day the market learned of Paulson's bailout proposals. Could Goldman have gotten word before others? Hey, we're not accusing anyone...

Bill Bonner
for The Daily Reckoning Australia

• Rising in Defense of Goldman Sachs
• Government Pretends to Punish the Bankers
• Pension System: A Conversation With Chile’s Former Labor Minister
• Only Hope for Obama is that the Economy Revives
• Government Sachs

What was America's Golden Age?

It is much too soon to write the history of America's decline and fall. Still, that doesn't stop us from guessing.

We would name the period between the fall of the Berlin Wall and the fall of Lehman Bros - a period of only 19 years - as the peak of US power and wealth. Of course, Americans were dreaming during those years. The dreams were the usual imperial sort - that the US Empire was such a benefit to the rest of the world that the foreigners would support it indefinitely. Rome didn't take any chances; it forced its conquered nations to render tribute...slaves...gold...and wheat. The American empire depended on trade...and the dollar. As long as the United States had a commercial advantage, the empire was profitable. But as the 20th century aged, so did the US economy. Its competitors - notably Germany and Japan - had a big advantage. They had been bombed out in the '40s. They could build anew. America's trade advantage slipped away...and then its trade balance went negative in the mid- '80s. It has been getting more negative almost every year.

The trade losses shrank after the fall of the House of Lehman. Americans cut back. But today we get news that the trade deficit has just grown more than in any month in the last 10 years. Have Americans suddenly become big spenders again? Probably not. But we'll have to wait for another explanation; we don't have one.

No account of America's glory years - roughly the period between the reign of George Bush I and that of his son, George Bush II - would be complete without mention of the events that happened on this day eight years ago. A small group of terrorists pulled off an amazing coup - bringing down two of America's iconic buildings, right in the heart of New York City...and on primetime TV! Historians might be tempted to use this event as a milestone, marking the end of the period of maximum happiness in the United States of America. We caution against it. It was only later that it became apparent that the US reaction to the terrorist incident was suicidal. The nation desperately needed to bring its ambitions back in line with its means. It needed to save and invest in new factories and new infrastructure. Instead, it wasted trillions fighting phantoms and nobodies. But as far as anyone knew, US influence, prestige and power remained near its zenith throughout the wars on terror and Iraq.

The fall of Lehman changed things. Then it was obvious that not only was America vulnerable, she was an enemy to herself. She had diddle- daddled during the glory years, dawdling with the lion cubs that would grow up and maul her. Now, in the period we are living through, she attempts to go back to sleep and rerun her balmy dreams. That is what "recovery" is all about - a return to the land of nod and nonsense...in which people think they can actually become wealthier by squandering money they don't have on things they don't need.

Fortunately, as near as we can tell, most private citizens are now awake. A report at the beginning of this week showed that they repaid debt at a rate four times faster than economists projected. Savings rates are rising. Spending is falling. People are doing what they should do - they're cutting back.

But the feds continue their efforts to sabotage the correction and destroy the empire. They have already blown-up the budget - with $9 trillion in deficits expected over the next 10 years. Now, they're working on the dollar.

Yesterday, the dollar fell to $1.45 per euro. Gold remained just below the $1,000 an ounce mark. And the Dow rose 80 points.

Stock market investors seem to be looking forward to another big bull market. But with the economy deteriorating, they are probably just dreaming, too. Median household income fell 3.6% over the last 12 months. Of course, that's just what you'd expect in a correction. But it's not what the feds were hoping for. So, they're pulling out all the stops to try to turn it around. Most important, they're pulling out the stop that keeps the dollar from rolling down the hill.

But the dollar will eventually come tumbling down...and those who are holding gold are going to be sitting pretty. Gold is, after all, the ultimate store of wealth.

The empire sinks into the mud. Yes, this is the downhill period...the slide into corruption...the period in which Juvenal complained that Romans were only interested in 'bread and circuses.'

When you are on the board of a decent corporation, for example, if you have a direct financial interest in a matter under consideration you're expected to 'declare an interest' and absent yourself from the vote. But in a mature democracy, the most self-interested citizens are those most likely to vote. Currently, about 20 million people work for government. About 45 million receive Social Security benefits. About 34 million depend on food stamps.

(People who count on the government to feed them, warned Jefferson, "will soon want bread." That doesn't seem to worry many people. But at least the state of Maryland has an Orwellian sense of humor about it. People who depend on government for food are given "Independence" cards.)

That's 99 million people who have a direct interest in expanding government outlays...with some overlap, of course. And it doesn't mean that every person receiving a Social Security check is going to back the feds. But it doesn't count all the millions more who get subsidies, bailouts, welfare payments (often masquerading as tax credits), government contracts, and so forth, either.

Well, how many people does it take to win a national election? Obama won with 63 million votes.

The dollar's weakness hasn't been missed by it biggest foreign holder - China.

Reported earlier this week in the Telegraph:

"'We hope there will be a change in monetary policy as soon as they have positive growth again,' said Cheng Siwei...talking about America.

"'If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,' he said.

"China's reserves are more than - $2 trillion, the world's largest.

"Mr. Siwei continued: 'Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets,' he added."

Then, two days ago, in came a report that China is going to issue bonds of its own - in yuan.

This news is a shot across the bow of America's imperial currency. It signals that China is moving into position to eventually challenge the greenback. Investors will have another alternative to the dollar...another bond issued by another government and backed by another economy...maybe one that is on the way up, rather than on the way down.

Meanwhile, Americans grow poorer. Bloomberg reports:

"'The decline in incomes we're seeing certainly has implications for consumer spending, particularly post-housing bubble when families can't tap into home equity through loans,' said Heather Boushey, a senior economist at the Center for American Progress, a research organization headed by John Podesta, a leader of the Obama administration transition team.

"The poverty rate is likely to keep rising through 2012, even after the recession ends, adding to pressure on the Obama administration to enact a second economic stimulus package, said Isabel Sawhill, a senior fellow at the Brookings Institution in Washington, a policy research group.

"'We will likely have not only a jobless recovery but also a poverty- ridden recovery,' Sawhill said. 'The stimulus money is going to go away long before the poverty rate peaks.'"

How can a consumer economy grow when its consumers are becoming poorer? We take up that question below...

Bill Bonner
for The Daily Reckoning Australia

• America’s Decline as a Great Empire
• Economy Has to Grow at 1% to Stay Even With Population Growth
• America, An Empire You Can Trust?
• The Rise in the Dollar Doesn’t Have Everyone Convinced
• China and its Trade

O! Bama! Where is thy recovery?

Yesterday, the world's stock markets took a hit. The Dow lost 186 points...following a very bad showing in China.

Is this the end of the rally?

Could be. We're not betting one way or the other. But we're pretty sure this rally is going to end...and end badly...sooner or later. So far, the rally surpassed the rally in '29 by a few weeks...but has not quite reached its magnitude. It will need another few hundred points to reach the '30 level.

But when the rally is over...then what?

Despite the fact that a majority (!) of economists polled by The Wall Street Journal say the recession is already over, there is no durable recovery.

Nouriel Roubini, writing in Forbes, explains why:

"Data from the US - rising unemployment, falling household consumption, still declining industrial production and a weak housing market - suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.

"Moreover, for a number of reasons, growth in the advanced economies is likely to remain anemic and well below trend for at least a couple of years.

"The first reason is likely to create a long-term drag on growth: Households need to deleverage and save more, which will constrain consumption for years.

"Second, the financial system - both banks and non-bank institutions - is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.

"Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending.

"Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth."

Roubini thinks the United States will climb out of recession towards the end of the year...but then, it could fall back into a 'double-dip' recession. Maybe he will be right. Maybe this downturn will resemble Japan's multiple recessions over the last two decades. Or maybe it will be a single, deeper and longer lasting slump - like the one in the early '30s. We don't know. Either way, it should be thought of as a depression, not a recession. Because it is fundamentally different. And the difference is: Recovery is impossible.

If the markets were to recover, it means they need to go back to the way they were. That, dear reader, ain't gonna happen. Because it can't happen. The economy can't go back to what it was. In the 2005-2006 period, it was in the throes of a credit cycle blowout...where it took more than $5 of new credit to produce one stinkin' extra dollar of output. Consumers had to borrow $100, in other words, in order for the GDP to go up $20. It was a period of madness that couldn't possibly be sustained...and now, can't possibly be revived. Who's going to invest in another condo development in Florida now? Who's going to buy derivative debt at 2006 prices? Who's going to build another factory in China to produce more things for American consumers who can't pay for them?

Well, ha ha...that's the funny thing; the Chinese ARE building more factories.

But we'll get back to that later. Comes word this morning that Florida has lost population, for the first time since 1946! People are leaving the Sunshine State because the big boom in suburban sand is over. A large part of the Florida economy was based on building houses for people coming down from the north. Now those people are going home and trying to pay off their debt. The point is, after a bubble...like after adultery...things never go back to where they were before. You can pretend that they are the same. You can act like they are the same. You can try to make them the same. But they never are.

A recession is merely a sprained ankle or a head cold. You can recover. But a depression is fatal. There is no going back. There is no recovery.

Trying to 'recover' from a depression is a futile fight with the future. Governments try to restore the old economy - as it was. They prop up the old industries. They bail out the failed executives and speculators. They pass out money to people, encouraging them to make more of the same mistakes that got them into trouble in the first place.

But there is no going back. It's a depression. The model has to change. The future...whatever it is...has to express itself.

The US budget deficit hit a record $180 billion last month. July's deficit was nearly $30 billion more than total tax receipts for the month. In July, the feds only took in $151 billion in taxes...giving it the worst margin in history. For every dollar of revenue, the federal government spent $2.15.

Not a very good business model. But the feds seem determined to stick with it - they're going to make it up on volume. Deficits are expected to exceed $1 trillion every year for the next eight years. And that assumes the economy 'recovers.' If it doesn't recover, the deficits will be much worse...with falling tax revenues and the need for even more stimulus.

The feds are running into the brick wall of the future. They've made promises - mainly to older voters - that now have to be fulfilled. And the number of older voters is increasing...as the Baby Boomer generation enters its retirement years. Social Security and health care promises alone will add trillions to federal deficits. By one estimate, US debt could rise to 300% of GDP by the middle of the century.

Of course, this poses a bit of a problem. US GDP is about $14 trillion. Three times that amount would be $42 trillion. Who's got that kind of money to lend to the US government? No one. The first reason being that the world doesn't have that much in savings. Second, because even if they did, they are unlikely to want to lend it to such a huge debtor. Of course, we're always surprised by what people are willing to do with their money - and anything is possible.

But more than likely the US will be forced to trim its promises...or inflate them away.

As dear readers know, we have become suspicious of inflation. Not that we don't expect it; in fact, we think we'll see it in its souped-up hyper version sometime in our lives. What we're suspicious of is the easy assumption that the feds can create inflation at will...and control it. They can't. They aren't that good. Even at inflation they are hapless and incompetent. And their hands aren't completely free.

First, they have to answer to the Chinese bond vigilantes. The Chinese are watching. If it looks like the feds are increasing the inflation rate - thereby reducing the value of Chinese savings - they could send the US government and the US economy into chaos simply by selling their stash of Treasury bonds.

Of course, the Chinese don't want to do that - because it would mean hundreds of billions in losses. But push them far enough...make them afraid enough...or cause them to get mad enough...and they could strap on their shootin' irons.

Second, there are also the ineluctable results of a major credit contraction...and a gross oversupply of capacity. Both are pushing down prices and could do so for many, many years. They can be overcome by aggressive use of the printing press. Argentina and Zimbabwe proved that. But neither Argentina nor Zimbabwe depended on credit from the Chinese. Inflation may be a monetary phenomenon, but hyperinflation is a political phenomenon...the feds only resort to it when they have no choice. We'll get to that point; but right now, it is still far away.

Bill Bonner
for The Daily Reckoning Australia

• Roubini Says Recession Will Continue Through End of Year
• We Expect No Recovery from the Economy
• Americans Have No Money to Spend Because They Already Spent It!
• China Was the Maker and the United States Was the Taker
• Lying Heads of the United States Congressional Budget Office

When Social Security was founded, the typical US worker at age 65 could expect to live another 11.9 years. But if today's official projections are right, by the year 2040 the typical 65-year-old worker can expect to live at least another 19.2 years. If the normal retirement age had been indexed to longevity since 1935, today's worker would be waiting until age 73 to receive full benefits and tomorrow's workers even longer.

In a report called "Demographics and Capital Markets Returns," Robert Arnott and Anne Casscells argue that the crisis is not in Social Security, but in demographics. "When an entire society ages," suggest Arnott and Casscells, "...the thing that matters most is the ratio between the workers to retirees. Unfortunately, the aging of the baby boom generation, which is a significant bulge in population, will cause a dramatic increase in the ratio between workers to retirees, one that will put enormous strain on society and cause friction between generations."

In the United States, as in other developed countries, the unfunded benefit liability for public pensions amounts to 100 percent to 250 percent of GDP. It is a " hidden debt " far greater than official public debt. Unlike in the private sector, these debts are not amortized as expenses over 30 to 40 years. And it may be worth pointing out that under normal conditions economies do not run such crushing deficits. They only do so in crisis mode.

The annual cost of Social Security benefits represented 4.4 percent of GDP in 2008 and is projected to increase to 6.2 percent of GDP in 2034, and then decline to about 5.8 percent of GDP by 2050 and remain at about that level.

And to the retiring boomers' other doubts and insecurities, we might add that US health care costs are expected to rise by 7 percent of GDP over the next 40 years - a rate that is more than twice as fast as other developing nations. The "old old," - those aged 80 and over - are predicted to rise sharply through 2050 and will dramatically increase long - term care costs as well as disability, dependence, and health care expenses.

In fact, by official projections, in 2030, the US government will be spending more on nursing homes than it spends on Social Security today. "Although people justifiably worry about Social Security," says Victor Fuchs, an economist who studies the health care industry, "paying for old folks' health care is the real 800-pound gorilla facing the US economy." Adding projections for Medicare and Medicaid 's expenditures to those of Social Security could raise the total cost to more than 50 percent of payroll taxes.

The fiscal kickers of health cost inflation and political demand for more long-term care benefits threaten to raise public spending dramatically in the United States. Between 2005 and the fall of 2008, we spent two and a half years chronicling the efforts of David Walker, the former comptroller general of the United States, and Bob Bixby, executive director of the Concord Coalition, to reign in reform and shore up the Social Security and Medicare systems. The project yielded a feature length documentary film, which earned us a trip to the Sundance Film Festival in January of 2008 and another to the Critic's Choice Awards in Los Angeles a year later. We published a best-selling companion book of the same title in late 2008. You're encouraged to delve into the numbers we presented in the film and book. They're truly mindboggling. But in many ways the project was dated the moment we released it to the public.

The credit crisis that reached a fever pitch developed in 2008 pushed the date of insolvency of these programs ever closer. On May 13, 2009, the Medicare Trustees warned that the fund they tap to pay for beneficiaries' hospital care will be insolvent by 2017 - two years earlier than trustees had predicted the year before. The program has been paying out more than it collects in taxes and interest since last year, in part due to a recession well underway. Medicare would have to deposit $ 13.4 trillion - $ 1 trillion higher than last year's estimate - into an interest-earning account today in order for the hospital fund to pay its scheduled benefits over the next 75 years. The program's total unfunded obligation, which includes doctor and prescription drug benefits, is $37.8 trillion. The trustees estimated that in coming years, Medicare spending will rise faster than workers' earnings or the economy as a whole.

Trustees say that while the financial standing of Social Security decreased more sharply than Medicare last year, the health program remains at greater risk of insolvency. The financial difficulties facing Social Security and Medicare pose serious challenges, the report concluded.

For Social Security, the reform options are relatively well understood but the choices are difficult. Medicare is a bigger challenge. Its cost growth can be contained without sacrificing quality of care only if health care cost growth more generally is contained. But despite the difficulties - indeed, because of the difficulties - it is essential that action be taken soon, particularly to control health care costs.

After the revised Social Security and Medicare announcement the world began to wonder: Can the US hold onto its AAA credit rating?

"The US government has had a triple-A credit rating since 1917," David Walker, now president and CEO of the Peterson G. Peterson Foundation, commented in the Financial Time s following the release of the Trustees report, " but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

"First, while comprehensive health care reform is needed, it must not further harm our nation ' s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country's future.

"Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us."

Of course, we must note that the whole credit rating biz is...well...corrupt. The agencies that are responsible for dishing out sovereign credit ratings (S&P, Fitch, and Moody's) are the same ones that left us all out to dry in 2007. (Of course, mortgage - backed securities get a AAA...housing prices never fall!) Rest assured, if Wall Street can buy its way into AAA, Uncle Sam surely can, too.

But even Moody's is starting to hedge their bets. They've since created three subdivisions within their AAA rating: resistant, resilient, and vulnerable...a corporate way of saying the good, the bad, and the ugly. While the United States isn't in the worst of the bunch, it's certainly not the best.

Regards,

Bill Bonner and Addison Wiggin
for The Daily Reckoning Australia

• Baby Boomers Are Ill-Prepared for Retirement
• Social Security a Bigger Scam Than What Bernard Madoff Schemed
• Trust Funds Con
• The US Federal Budget
• Austerity is Missing from the Financial Bailout Debate

And speaking of colossally stupid government programs, you may have seen the news that the U.S. House of Representatives passed a climate change bill on Saturday by a narrow vote of 219-212. The cap-and-trade bill, otherwise known as Waxman-Markey (for the nominal writers of the bill) mandates that U.S. manufacturers and utilities reduce carbon emissions 17% from 2005 levels by 2020 and 83% by 2050.

Under the sausage making process that is the American Congress, the bill was filled with compromises. Congressmen from coal-producing states or states with lots of manufacturing jobs had to be bribed into supporting it through various means. It must now go the Senate, which must pass its own version of the bill.

If the Senate bill is different than the House bill (and it almost always is, given the different agendas in both bodies and the need for more bribes), the two bills go to "reconciliation." That's where a committee made of members from both houses settles on a final compromise version of the two bills and sends them back to their respective bodies to be voted on. Then it gets sent to the President to become the law of the land.

By the way you may have missed an amendment to the bill that's stirred a bit of controversy. It was inserted the night before among the bill's 1,200 pages, which you can be sure none of America's elected officials actually read. The amendment placates Congressmen from Rust Belt states who worry about losing even more manufacturing jobs to the developing world (China). It requires the U.S. President to make a "border adjustment" on goods from countries that do not cap or reduce carbon emissions by 2020. It's a tariff.

Already President Obama has backed off that particular amendment. He says, "At a time when the economy worldwide is still deep in recession and we've seen a significant drop in global trade, I think we have to be very careful about sending any protectionist signals out there." Very careful, sure. But you already did send the signal didn't you?

For what it's worth, we think this was all an exercise in political window dressing to get some version of a bill passed. If the Senate and the House actually agree on a climate change bill that puts a high tax on carbon, then the apotheosis of Obama will be complete.

We will take The One at his word, though. Besides, as everyone knows, the real purpose of the bill is not to start a trade war (although it may do so). The purpose is to make conventional energy more expensive AND-in an era of declining government tax receipts and rising liabilities-to create a huge new source of government revenues by taxing carbon. It's a revenue and power grab by an institution (the Nation state) that finds itself increasingly off-balance.

It's also a massive project in socioeconomic engineering that ignores the reality (and physics) of energy generation in an industrial society. It's true the world could benefit from cleaner and cheaper energy. But cleaner and more expensive energy is a recipe for economic suicide. It's something Western nations seem particularly keen on committing, although we can't really figure out why. It could be that the global Left simply finds modern life aesthetically ugly and consumerism (with all that pesky individual choice) a vulgarity that should be destroyed via legislation.

But speaking strictly in economic terms, unless a region or a country has ample hydroelectric or geothermal resources, it's impossible to meet base load electricity needs reliably with renewable energy. Advocates envision a world full of ultra-long life batteries, windmills, and solar farms. But it's just a fantasy. If the climate bills become law in Australia and America, it will accelerate the deindustrialising of Western economies and mean the transfer of even more manufacturing jobs to the developing world.

Of course maybe that's just what the architects of these laws want. Who knows? We know they want to tax productive enterprise and make the bulk of the population dependent on government handouts. That makes people compliant and easily controllable. That is big government Utopia. Advancing the fears of climate change is the easiest way to get more control.

Politics aside, there is an investment angle to this, which we've been developing at Diggers and Drillers and which Kris Sayce has been profiting from at the Australian Small Cap Investigator. It's natural gas and liquid natural gas (LNG).

In short, we'd expect to see the construction of a lot more natural gas fired power plants in the coming years in the West (although they are more expensive than coal-fired plants). All those re-chargeable plug-in hybrids have to get their electrons from somewhere. If it's not going to be coal (which will be taxed out of existence), it's probably going to be cleaner-burning natural gas power plants, powered by both conventional and unconventional gas.

Right now, global LNG capacity is rising and stockpiles are fairly high. But if you keep your eye on the big picture and we see a transition of the world's power plant fleet from coal to natural gas, it obviously favours gas producers and explorers. Australia is moving ahead by leaps and bounds in this area with conventional off-shore production in the North West Shelf and Timor Sea and more unconventional production (hopefully) from coal-seam-gas in Queensland.

Dan Denning
for The Daily Reckoning Australia

• The Energy Resources Are Out There
• Messages from Copenhagen Climate Change Conference
• Rising Coal Prices to Increase Electric Bills in Australia
• Unsustainable Energy Trends
• A Hot Future for Geothermal

We celebrate with the victims when a swindler like Madoff is brought to justice. Yet there is a vastly larger fraud being perpetrated on all Americans, and it's unlikely that any of the perpetrators will ever be jailed for their crime.

Bernard Madoff defrauded a few hundred clients of some $65 billion. Yet his scam pales next to the swindle being perpetrated at this moment on hundreds of millions of Americans who have been told they have accumulated more than $40 trillion in future retirement benefits.

This scam is the Social Security system.

Those who conceived the Social Security swindle promised that it would end the plight of the aged and disabled by guaranteeing them "security" - a steady income in disability and old age. It was promoted as a life raft that would carry everyone safely through to the end of his or her days.

Today, 74 years later, Americans continue to be told that regardless of what happens to the economy, the government will never renege on this promise. As the population has aged, Social Security beneficiaries have become the biggest political lobby in America. To get elected, any political candidate must participate in the swindle. Both as a candidate and now as President, Barack Obama has consistently maintained that the Social Security program's financing is basically sound, and can be assured far into the future. He's lying.

I became aware of the technique of the fraud in 1975 when Arthur Andersen & Company published a lengthy report titled "Sound Financial Reporting in the Public Sector." It disclosed both the magnitude of the crime, and the simple accounting subterfuge used to disguise the fraud.

The report pointed out that the government keeps its books using the "cash basis" method of accounting rather than the "accrual basis." The cash basis is what you use to balance your checkbook. If you deposit $50,000 in your account for the year and write $49,000 in checks to cover your expenses, your checkbook will show a $1,000 surplus for the year.

However, this does not tell the true story. If you took a vacation in December and ran up $5,000 on your credit card, but the payment didn't come due until the following year, your true expenses for the year were $55,000. You actually ran a $4,000 deficit which didn't show up in your checkbook. Every rational business owner knows that to track the true condition of the business he must add in the cost of purchases he made but must pay for in future years. Sound businesses always use the accrual method of accounting.

In its 1975 report, Arthur Andersen reviewed the U.S. federal budgets for fiscal years ending 1973 and 1974, and came up with shocking figures. Using the cash basis of accounting, the government had reported federal deficits of $14.3 billion for 1973 and $3.5 billion for 1974.

Recalculated according to the accrual method and including future Social Security payments and government pensions, the true 1973 deficit jumped from $14.3 billion to a staggering $86.6 billion. The 1974 budget was even worse, jumping from $3.5 billion to just over $95 billion. The government underreported its deficits by more than $160 billion in a two-year period.

Peter G. Petersen, former Chairman of the Federal Reserve Bank of New York, began sounding the alarm on this looming financial catastrophe more than a decade ago. In his 1996 book, Gray Dawn: How the Coming Age Wave Will Transform America and the World, he pointed out that if federal law required Congress to fund Social Security the way private pensions must be funded, the annual federal deficit in 1996 would have instantly risen by some $675 billion. Add in lavish and unfunded federal-employee pensions and the deficit would have risen by $800 billion. Add in Medicare and it would have risen by more than $1 trillion.

The cash and accrual deficits that Arthur Anderson discussed in his 1975 report seem trivial compared to last year's federal deficit of $454 billion, and especially compared to this year's projected deficit of $1.8 trillion. Decade after decade the total of the swindle has been inexorably rising, until today the estimated shortfall owed Americans is an incredible $40 trillion. Nor has it stopped. The total continues to rise at a rate of $2 to $3 trillion per year.

Bernie Madoff was able to get away with his fraud by using the same technique as Charles Ponzi did in the 1920s. He sold fictitious securities, promised a high return, and paid off old investors out of monies taken in from new investors. It collapsed when new victims could no longer be found to support withdrawals from old victims.

The Social Security swindle has worked exactly the same way. It receives "contributions" in the form of FICA taxes, pretends to place those funds in trust, and pays benefits to current retirees out of taxes collected from current workers. Just as in the case of Madoff, there is no trust, there is no income to the non-existent trust, and the payments are simply made from current collections. Madoff's scheme lasted 20 years before collapsing. The Social Security swindle is now in its 74th year...the end is near.

It's clear that Social Security cannot fulfill its promises to future retirees, but the casualties will not be limited to those victims, like Miriam Siegman, who find there is no life raft to carry them safely through retirement. In order to continue the fraud, politicians have no alternative except to issue more promises. Retirement checks will come, but they will be financed by more federal borrowing. Cash basis deficits will rise. Treasury IOUs will be converted by the Federal Reserve into dollars. As the monetary inflation morphs into price inflation, the victim list will swell to include everyone who doesn't see it coming.

Last year, former Comptroller of the Currency, David Walker, teamed up with Addison Wiggin of Agora Financial to produce an eye-opening movie, I.O.U.S.A., which documented the stunning financial swindle being perpetrated on the nation. This compelling addition to Petersen's disclosure of the government's financial fraud is being widely shown, and has just become available on DVD.

Unfortunately, we will never enjoy the sight of the politicians responsible for the Social Security swindle being sent to jail, but we can protect ourselves from their fraud.

It's time to don your lifejacket.

Best regards,

John Pugsley
for The Daily Reckoning Australia

• Trust Funds Con
• Financial Difficulties Facing Social Security and Medicare Pose Serious Challenges
• Who Was the SEC Harassing Instead of Madoff?
• Baby Boomers Are Ill-Prepared for Retirement
• Madoff Astonished SEC Didn’t Verify His Claims