This rally has gone on for so long most people think it is not a rally at all, but a new bull market. Worldwide, it has taken equities up some 73%...making it one of the greatest rallies ever.

What are we to think? Are we alone in thinking it's still a trap? What happened to the problems that led to the crisis of '07-'09?

If you don't think about it too much you might think everything is fine. Stocks are up. Business profits are up. GDP is up. Housing and unemployment seem to be stabilized. What's not to like?

The recovery is a done deal as far as most people see it. The rescue efforts, initiated by the feds, were a big success...or so they believe. It has been 12 months since the bottom...and the world still has not ended. Everything is back to normal...isn't it?

The problem in '07-'09 was that too many people owed too much money.

And what has happened to change that? The net level of indebtedness in the US has actually gone up since '07!

Huh? How's that? We're in a de-leveraging phase, aren't we?

Well...yes...but only in the private sector. The feds are still adding debt.

Let's look at the private sector first. There, we find unemployment still around 10%. Adult males in their prime working years, however, have fewer jobs than ever before. One figure we saw shows that only 4 out of 5 of them are working.

That is just the beginning of the problem for these fellows. They're getting fewer college degrees, compared to women, than ever before. They're earning less money too - again, compared to women. Fewer are the chief breadwinners in their households. And fewer are even in a household at all - more are alone.

Let's not get distracted by the suffering of the masculine part of the population...

..we're looking at what is going on in the broader economy. Is it healthy and growing? Or is the stock market just a honey trap...a bear market trap for the unwary investor?

The private sector is de-leveraging. Not only is the unemployment rate high, the typical family also lost a lot of money when its house went down in price. And since the typical householder is also in his 40s or 50s, he has to consider his retirement and how he's going to fund it.

Stocks? While they've bounced back nicely, the stock market is still well below its highs...and still in a losing position over the last ten years. A 73% gain sounds nice, but it would take a 100% gain to recover the losses of the '07-'09 bear market.

Houses? One out of four mortgaged houses is still underwater. In some new developments, the figure is as high as one out of two. And there is little likelihood that the owners will be high and dry anytime soon. People no longer expect to retire on the gains from their houses.

This leaves the middle-aged householder without much choice. He has to save money. Remember, the boom of the 2003-2007 period was caused by dis-saving. Now, a higher savings rate will mean less spending for many, many years. This is a fundamental and important change of direction for the economy. It will restrict business growth and restrain profit growth too.

So, is it possible to slough off the crisis and return to business as usual? Nope. Not possible. You can pretend that things are back to normal. You can act as if they are back to normal. You can invest as though they are back to normal. But you can also lose your money.

But they're not normal at all. They're different. The 1982 to 2007 period was...mostly...a boom time, caused by rapid increases in debt, asset prices, and consumer spending. The next period is...mostly...a bust time - when asset prices, private debt, and consumer spending go down.

Sooner or later, but probably sooner, the stock market will realize it. Our Crash Alert flag - tattered and faded - is still flying.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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Not much in the financial news worthy of comment this morning...

The Dow gained $13. Gold lost $13. Nothing much to say about it...

So we will comment on something beneath comment...something so low we have to dig down to find it...something so unworthy we hardly imagine we are mentioning it...something in the newspapers...

We're talking, of course, about politics...

The love-fest with politics is heating up. The drugs have been passed around. Now, the clothes are coming off...

"France keeps steady course in economic upheaval," says a headline at the International Herald Tribune. Steady course? You bet. It kept subsidizing, bailing out, protecting, coddling and otherwise meddling in its economy - just like it did before the crisis began. Had it not done so, the story continues, France might not have been the first major economy out of the worldwide recession.

On the other hand, the French never went deeply into debt... So maybe they just didn't have so much exposure to the worldwide debt crisis in the first place.

Never mind. The papers don't know what the problem is, but they're convinced that government interference is the solution.

Over at The Financial Times, Clive Crook is breathing hard, too. He reckons that the "downturn called for a big stimulus," and that the US stimulus effort headed off a worse recession. He then explains that the feds' stimulus really didn't stimulate at all, it merely offset a decline in spending at the state level. State tax revenues fell; states spent less. State tax revenues declined $87 billion in the last 12 months, the biggest drop on record. The feds made up for it by spending big.

Meanwhile, The New York Times tells us that the whole downturn is now behind us. The economy is "surprisingly normal," it says.

The US economy is some 11 million jobs short of full employment. Nothing very normal about that. But February saw an unexpected upturn in consumer credit, reports the Times. And unemployment seems to have bottomed out, adds The Wall Street Journal.

Surprisingly normal?

Well, there's a big difference from something that looks surprisingly, reassuringly normal...and something that is actually working normally.

Which is it?

The New York Times is right; it is an economy that looks surprisingly normal...

Zombies can look surprisingly normal too. If you clean them up.

Bill Bonner
for The Daily Reckoning Australia

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If that's not the sort of discussion that interests you, you might want to go take a powder or read a good book. These are murky waters we're wading through. So we'll do our best to clear them up for you. But it's probably going to take two days. Today, we'll look at the case against deflation. Tomorrow, we'll look at what it means for Australia.

All good debates begin with a proper definition of terms. Rather than defining deflation in our own way, we'll leave it up to one of its most consistent and articulate (and accurate) advocates, Robert Prechter. He's written about it for years. But for a short course on what he's predicting and why, check out this video.

In the video Prechter says, "The next big phase [in the cycle] is a credit implosion where people who are debtors are going to be scrambling for dollars to pay off their debts and the creditors are going to be dunning the debtors to pay them back....The scramble will be for dollars not for things."

The investment outcome of Prechter's scenario is bullish for the U.S. dollar and U.S. Treasury bills, where he says, "the chances of default are low." Prechter's argument is based on the idea - which we happen to believe - that the U.S. Federal Reserve is unable to prevent falling asset values. This would lead, by Prechter's reckoning, to falling stock, commodity, and real estate values.

All of that seems right to us so far. The deflationary argument depends on the collapse of both the shadow AND the real (deposit taking) banking system. The shadow banking system is the murky world of credit, securitisation, and derivatives which currently supports and/or holds some $600 trillion in assets. Yes that's trillion with a T.

Most of these are interest rate and credit derivatives. As we learned in the last two years, the big risk here is to institutions which owe and own these obligations amongst one another. In our view, the degree of interconnectedness among these obligations (they still aren't unwound) still makes the entire global financial system vulnerable to a systemic shock and/or total collapse.

It nearly happened last time with Lehman and frankly not much has changed since. A good old interest rate spike that's not in anyone's model might be the sort of thing that precipitates the next crisis. After all, that's the way these things generally begin.

You could make the argument that it shouldn't really matter to the real economy if a bunch of global institutions find out they can't settle their obligations to one another. Why not just forget the whole mess and start other? After all, most of these derivatives are just insurance policies of some sort. Can't we just cancel the policy?

Probably not. These positions are held in conjunction with myriad leveraged bets on the direction of other asset prices. They are hedges. No one is going to walk away from them. But more importantly, the connection between the shadow banking system and the real banking system is much more substantial than you might first imagine.

So much of today's funding, financing, and lending is done by the shadow banking system through securitisation and money markets and income and mortgage trusts. The real economy is tied to the shadow banking system in just the way that you are tied to your own shadow. And the real, deposit taking, depostior (taxpayer)-insured banking system is not much better off.

For example, my colleague Porter Stansberry reported today that in the U.S., 7.1% of commercial real estate loans are more than 90 days overdue. The FDIC reckons that over 700 U.S. regional and local banks are "danger" banks. The reason is that these banks own mostly commercial real estate. It's their main asset. And unlike their money-centre big brothers on Wall Street, these banks aren't going to be recapitalised or bailed out at taxpayer expense.

Students of the Great Depression will know that widespread bank failures led to a contraction in the money supply. Banks, more than the central bank, are the engine of money and credit growth in a fiat money system. Take away several hundred banks, and you get lenders not making loans. Money supply shrinks. Cash and Treasuries gain in value.

In fact, when you couple the wounded regional banks in the U.S., who are massively exposed to one dangerous asset class, with the potential collapse of the shadow banking system from another interest rate/liquidity/solvency shock, you begin to wonder how deflation is avoidable at all in the near future.

We have a laboured three-part answer. We're going to lay it on you now. It begins with the destruction of the shadow banking system. It accelerates with the paralysis of the regular banking system. And it concludes with deliberate devaluation of the currency via monetary and fiscal policy to make up for a completely destroyed credit system.

It's easier than it sounds.

Granted, it probably sounds absurd that you can have a $600 trillion wipe-out in the shadow banking system and have inflation. But there are two points to make here. First, it's hardly believable that an institutional panic and bank run in the shadow banking system (what happened last time) would actually boost confidence by individuals and consumers in the overall banking system.

True, it might increase people's preference for liquidity and cash. Stocks, real estate, and bonds would fall. But another swift collapse in the shadow banking system would be a hammer blow to already fragile confidence in our financial system, including the value of paper money itself.

But a more technical response is that as the shadow banking system is unable to finance economic activity and speculation, either that activity goes away (a Greater Depression) or someone else tries to fill the gap. We'll assume for the moment the regular banks won't do it. That leaves the government.

And in fact, that is what you had in the U.S. following the last crisis. You got an alphabet soup of Fed-backed programs to provide all sorts of credit...to students, to money markets, to car companies, to corporations. This list grows longer by the day. And what it means is that the only provider of credit in a post-shadow banking world is the public sector: the Fed and the Treasury.

Whether these are loan guarantees or outright loans or the purchase of securitised mortgages (Fannie and Freddie) it amounts to the same thing: a huge transfer and burden to the public sector balance sheet. Whether it's monetisation or guarantees that add to Federal liabilities, both are dollar bearish. The transfer to the public sector then, results both in destruction of asset values and inflation in the currency.

But wait! You can't have inflation if there's no one to make loans and use the money multiplier to turn growth in the monetary base into new Federal Reserve Notes. That is, if the shadow banking system collapses, won't this lead to the same no-risk paralysis with the big banks that has led to their holding trillions of dollars in excess reserves with Central Banks?

Why yes, it will. But this also argues for inflation. Here we're going out on a limb. But what we're arguing is that as the private sector is less able or willing to dole out credit into the economy, we're entering a world where the government is going to bypass the middleman and do the job itself.

This happens in three ways. First, the government can buy securitised assets to fund non-bank lenders. The AOFM does this in Australia to support housing prices and non-bank lending to first home buyers. It's done in the State at a much more comprehensive level. In effect, the entire American mortgage market has been nationalised with the government guaranteeing and buying trillions in mortgages.

This is the future. More nationalisation of key lending institutions. If the private sector won't do it, the Feds will. But at great cost. Each new loan guarantee weakens the public balance sheet and the currency. Thus the retreat of the banks from credit creation hastens the day where fiscal and monetary policy are forced to be more transparently absurd and redistributive.

The second way in which the government becomes a lender is through extended unemployment benefits. The dole. In some States, it's possible to receive 99 weeks of unemployment benefits. This doesn't mean dole bludging has become a full time job. But it does mean that the structural changes to Western labour markets wreaked by globalisation are wage deflationary.

To us, this means a larger regular expenditure on the unemployed. The U.S. is headed the way of Europe, with higher structural unemployment. Whether it can afford to pay for this while fighting two wars, spending a $1 trillion expanding health care coverage, and preparing for an increase in entitlement payments...well you do the math.

The net result of the increased burden on the public sector in supporting private incomes is a weaker currency. It always comes back to that. And it's true for the Euro, the Yen, and the Dollar. It's true, in fact, for all paper money. This is why we believe the end of the super cycle in paper money is bullish for precious metals (not deflationary).

The third way in which the government bypasses the traditional banking sector to get money into the hot little hands of consumers has already been suggested by Ben Bernanke: via helicopter. And this really is the greatest argument against the deflationary theory.

In one sense, Bernanke was right. The Fed can create an infinite amount of digital dollars. It can expand its balance sheet infinitely too. It can buy assets directly. It can buy gold mines. It can probably create a market that securitises future consumer wages and pays you now for them. You literally mortgage your wage-earning future (or perhaps you get an early pay out on your social security).

The only real restrictions on the Fed's ability to create money are rising bond yields (market discipline on currency mismanagement) and political interference. On the first issue, the Fed has some covering fire. Global investors have to own something. And right now they prefer the dollar. Unless the Fed does something radical and reckless, it can expand its role in providing credit directly to the real economy without doing huge damage to the dollar...mostly because there are so few other good options.

Obviously we think gold is a good option. But for nations like China with trillions locked up in dollar-denominated assets, what options are there?

You could argue that the U.S. Congress and the President would not allow the wilful debasement of the currency via an expanded Fed role in direct lending. But we think just the opposite. Those ass-clowns will be begging for it.

When commercial real estate blows up regional banks, we predict you'll see the President declare victory in Iraq and Afghanistan within months, bring the boys home, and cut defence spending by 30%. The money will pour into new lending and "jobs" programs to support the economy. Fiscal and monetary policy will work hand in glove to pump funny government money directly into the consumer economy. The only result there can be is hyperinflation.

So, it's possible - likely even - that you're going to see across the board falls in stocks, real estate, bonds, and commodities....AND inflation. Whether we got the proper sequence right, we're not sure. But the combination of a shattered shadow banking system, a paralysed banking system, and a terrified government certainly do add up to massive inflation.

Tomorrow, is this just an American tragedy? Or is Australia at risk too? And quite obviously, what should you do?

Dan Denning
for The Daily Reckoning Australia

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- Arthur Rimbaud, "The Drunken Boat"

The news yesterday pushed against us like a gentle wind. Pending house sales were bad. Consumer spending was good. Unemployment was bad. Manufacturing was good.

The Dow rose 47 points. It has moved without much conviction for several weeks. It can't seem to make up its mind. We thought it had headed down decisively a few weeks ago...and then, it stabilized...and wandered about...

Gold has more sense of destiny about it. It's been in a bull market for the last 10 years...and shows no sign of wanting to do anything else. It lost $11 yesterday, but still trades at $1,132...not that far from its all-time high.

Gold is in a real bull market. As near as we can tell it is still in the developing stages. There are a few old gold bugs around. But the public is not yet talking about gold. Investors are not yet adding major positions in gold to their portfolios. Ordinary people are not yet expecting gold to go to $5,000 or $10,000 an ounce.

But the news keeps coming...the opinions...the rants...the data...and the theories...

This way and that...we begin to feel like a "drunken boat." That was the title to a poem written by a 17-year-old Frenchman named Arthur Rimbaud. It describes how we meander. We are driven by the winds...and pushed by the back-eddies... Turning our bow this way ...and then that way...

Never quite sure what direction we're going...or what to think... No one is in control...

And still, the current continues...and we keep heading downstream...carried by the great river...always moving along.

One day we're fascinated by what is going on in Japan. The next day it's China. Some days we think we might somehow muddle through...on others, we're sure something is going to blow up any minute.

But that river just keeps rolling along...and we're on it.

Where does it lead? Well, that's the point. We're not sure...

All we're sure about is that it doesn't lead where most people think. They think they see a 'recovery.' Forget it. Won't happen. We could have another speculative period...but it won't be like the Bubble Epoch of 2005-2007. Houses would have to go up 20% just to get homeowners' heads above the water. Then, maybe they could borrow and spend like it was 2005 again...but that's not going to happen. People don't have the incomes...or the credit...to bid up house prices again.

Here's a headline from The Wall Street Journal: "Employment of Adult Males at Record Low."

Where does that lead? We're not sure...but we don't think it leads to 'growth' in the US economy. Instead, it leads to bankruptcy, deflation...and maybe insurrection.

And what about the Chinese economy? Isn't that growing at breakneck speed - over 10% per year?

The trouble with breakneck speeds is that you do break your neck. China should slow down...or it's going have an accident. And if it slows down, the whole world slows down with it...

And as to that 'growth' - it's counterfeit anyway. It's not real growth...it's ersatz growth, caused by greater and greater government involvement and spending. The feds (the haulers) pretend to be in control. They want us to believe they are in control. But they are out of control themselves!

Can increasing government spending really make people more prosperous?

Show us an example!

Bill Bonner
for The Daily Reckoning Australia

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Market flash:

The Dow was flat yesterday. Gold rose $2. And Greece said it was making progress towards cutting its deficit.

Yesterday we looked at America's most miserable cities. Today, let's take a gander at its new "ghost towns."

There are many towns and cities that are losing population...losing key industries...and probably on the verge of extinction. USA Today mentioned some of them in a cover story this Tuesday.

Ravenswood, W. Va., for example. It has 4,000 people and one major business. It's a one-horse town, in other words, and the nag is leaving. The aluminum works are partly shuttered already, says USA Today; the rest is for sale.

What's going to happen to Ravenswood? It could become a ghost town.

There are already dozens of towns in West Virginia that are inhabited mostly by ghosts. They're relics of the booms and busts of the past. Mining, logging, railroads - each one created it own towns. Then, the profitable industries of the 19th and 20th century became unprofitable somewhere along the line. People left. Those who remain live among the shades.

The booms and busts of our time are simply claiming more victims. Cleveland is losing population. So is Baltimore. So are dozens of US cities.

"In the America where things are made the recession has a depression," continues the report. "According to a new Northeastern University study, one in every six blue-collar industrial jobs have disappeared since 2007."

And one in five adult males of prime working age is out of work. There are fewer and fewer factory towns in the US...and fewer and fewer jobs for people who work in them. And now comes word that auto sales in February fell nearly 4%. And early estimates suggest that the job report coming tomorrow will be depressing.

"Industrial workers are dinosaurs," says one laid-off worker, now retraining to be a traveling nurse.

Hmmm... Let's see. How does this work? No one makes anything anymore. We all become service industry workers...looking out for one another. I give you $5 for cutting my lawn. You give me $5 for cutting your hair. Neither of us has a penny more. How then do we afford to buy anything?

"An industrial town makes products that bring wealth into a community; a post-industrial ghost town as a zero-sum economy - people in marginal jobs 'serving and paying each other,'" says USA Today.

Services don't make people wealthier. They may make them more comfortable. But real prosperity requires real stuff - food, cars, tables, light bulbs, iPads.

Of course, you could offer services to people who make these things. A small nation, such as Singapore, for example, could earn a living by offering financial services. A Caribbean island could offer vacations. But what can a great nation like the US offer? It can't get by on services. And it can't support half its population on welfare, unemployment and food stamps. It needs manufacturing...it needs to make things...and sell them.

Why doesn't it do that already? How come so many people are out of work? How come men can find jobs?

Ooh la la...too many questions. But when was the last time you heard a mother proudly announce that her son was going into manufacturing? Or that he was learning to be a machinist? When was the last time you saw a major factory under construction? When was the last time you picked up something in a shop, turned it over and found "Made in America" stamped on the underside?

Bill Bonner
for The Daily Reckoning Australia

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Unemployment claims just came in higher than expected.

And new house sales in January were at their lowest ever. Pundits were quick to blame the snow. But sales were off even in areas that had better-than-usual weather.

Household income has gone nowhere in 10 years. Stocks have suffered a lost decade too. And now Ben Bernanke says we'd better be careful...because the recovery ain't no sure thing.

The Fed chief has no idea. But average people know what's going on. They know how hard it is to find a job. If you're in the building trades...or you have only a year or two of college...you're pretty much out of luck. You may have to retire before you ever start work again.

That's why there was such a big drop in consumer confidence.

But look on the bright side. Building more houses for people who couldn't afford to live in them was not exactly the greatest business strategy. And all those people who were appraising, mortgaging and selling houses can now find more useful work. Real jobs. Doing something more useful. What are those real jobs going to be? We don't know yet. But it could take a long time to find out. And in the meantime, we have a depression on our hands...

So, let's enjoy it...

How do you enjoy a depression? Well, the first thing is to make sure you're not in its way...

Dear readers may not know this, but in addition to writing The Daily Reckoning your editor also has a serious job...

Yes, in the morning he is a moral philosopher...gratuitously insulting public officials, whole professions, and entire nationalities. He is grateful to them all...they make life so entertaining! Imagine what kind of world we would have if people minded their own business and got on with their lives... People would be richer and happier, we don't doubt it...but at whom could we point a finger and laugh?

No, dear reader, the world needs its bumblers, fools, politicians (are we repeating ourselves?), grifters (sorry...we did it again!), and megalomaniacs. It needs someone to challenge the gods from time to time. Otherwise, the gods wouldn't have the fun of whacking them. And we wouldn't have the fun of watching.

But getting back to the point...what was the point? Oh yes, the point is we have a serious job to do too. In addition to writing about the world of money, we actually have to live in it.

You see, we have a Family Office...a little group of researchers and analysts that actually has to make decisions... In the afternoon, we have to decide. What to do? Long or short? Buy or sell?

One thing we need to be on guard against is allowing our emotions to take over. For all our deep thinking and cynical detachment, we're human too. We get emotionally attached to our own ideas. Then, we're very reluctant to give up on them...no matter how bad they turn out to be.

We remember...sadly...our own feet dragging after the bull market in gold of the late '70s. We didn't want to sell. So we delayed...we hesitated... By the time we realized how wrong we were we didn't have to sell. The bear market in the yellow metal was over! Gold had hit bottom. Gold was down 70% from the top. Much more in real terms.

This afternoon, your editor's aging aunt called from Pennsylvania.

"This economy has been very hard on my family," she explained. "I've got two sons-in-law...and they're both laid off from their jobs."

"What do they do?" we wondered.

"One drives a truck for a steel producer. The other is in construction. There's just not much work, I guess."

Nope.

And that's why, despite all the recovery talk, real people are turning real gloomy. Consumer confidence just registered its lowest reading since 1983. People don't have jobs...and they're beginning to worry that it could be a long time before they work again. Mortgage demand just fell to its lowest point in 13 years. State tax receipts are still falling - for the 5th quarter in a row. And the number of problem banks just rose 27%.

Recovery? Forget it. There is no real recovery. This depression has to run its course, like it or not.

You've heard us say that a depression is a period of transition from one economic model to another. You might ask: what's an economic model? And what economic model are we leaving behind? What economic model are we going towards? And what's this got to do with monetary and fiscal stimulus?

Good thing you didn't ask those questions before. We didn't have any answers. But here is David Goldman with a partial explanation:

"There is some analogy to the Great Depression in the present situation. Between 1918 and 1939, American agriculture was in permanent decline, because the end of the First World War reduced demand for American exports, and because the substitution of the tractor for draught animals freed up an enormous amount of land set aside for animal feed. There was nothing to be done but to get the farmers off the land into other occupations, and that was not accomplished until the Second World War."

The farmers found work in wartime factories...and in military service. After the war, they took up new jobs, in a new economy with new factories and new professions.

What work will today's laid-off construction workers find? Darned if we know.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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The Dow rose 91 points yesterday. Gold fell $6.

Officially, the crisis is over. Everyone says so. Central bankers and Treasury officials have been congratulating themselves. It's been a year now since the end of the world didn't happen. These fellows take credit for it.

Bernanke said yesterday that he'll keep the monetary spigots wide open for a while longer...but that's just because the recovery is fragile. He also talks of an 'exit' from stimulus programs, now that the economy is getting back on its feet.

Claptrap! Balderdash! Flimflam!

The mainstream economics profession is guilty of dereliction of duty. They should be telling people that this 'recovery' is a scam. They should be warning investors that the markets could fall apart any day. They should be buying gold and selling US Treasuries...and explaining to the politicians that you can't buy your way out of a depression with phony dollars squandered on wasteful projects!

Instead, the dopes are patting each other on the back...praising themselves for saving the planet from destruction.

But what really has gone on? And what's going on now?

Glad you asked.

First, there is a real economic phenomenon going on - the depression. It's alive and well...and doing just fine. Households are de-leveraging. Businesses are building up cash. People are losing their jobs. Savings rates are edging up.

Almost everything is happening as it should.

Depressions are times of falling prices. Markets are always discovering what things are worth. In a depression, they find that assets - stocks and real estate primarily - are not worth nearly as much as people thought.

That's why we have our 'crash alert' flag still flying. Prices are vulnerable to sharp, unannounced drops until they finally get down to real depression levels. Since that hasn't quite happened yet...we figure it's still to come.

On the employment front, this depression has put more than 6 million people out of work. And every month, more people join the unemployment ranks. So far, so good. The US economy didn't need so many marble countertop installers and so many mortgage refinancers. (If only something could be done to get rid of lobbyists!)

But the worst thing about a depression is that it holds jobless people prisoner for so long. Many of them will become lifers...they'll never work again.

In that regard, this depression is similar to Japan's 20-year depression, 1990-2010. After the bubble burst, the Japanese...who were aging faster than any race ever had...figured they needed to get serious about saving money. So, they cut back on spending...and saved. Domestic spending collapsed. Fortunately, the rest of the world - especially Americans - were still spending their fool heads off. And Japan is an export-led economy. Even so, with its own consumers dragging their feet, the Japanese economy didn't go very far or very fast.

The Japanese put their vast savings, directly or indirectly, into Japanese government bonds...helping the government fund its massive stimulus programs. Of course, the stimulus programs were a waste of money. The economy never really recovered...and now the government is expected to have gross debt equal to 200% of GDP next year, according to the IMF.

For reference, the US is expected to reach 100% of GDP next year. Britain is hard on America's heels with debt at 94% of GDP.

And now Americans are entering retirement savings mode too. The biggest age cohort - the boomers - need to do some fast saving in order to finance their retirements. They're cutting back...not just temporarily...but permanently. They will never, ever again spend money like this did during the big bubble years 2003-2007. That's what makes for a durable depression...

Another thing that makes for a depression is a lack of lending. Bank credit is still falling. Households cut back because they need to get out of debt...and save money for retirement. Businesses cut back too. New projects typically don't do well in a depression. Small businesses struggle...and fail. Big businesses get bailouts and subsidies. Depressions are times to neither a borrower nor a lender be.

Debt is only increasing at the government level. But that's another story for another day...

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Japanese Government Displays Generosity as Prices Fall in Japan
• Japan and its Economy Did Not Have Secret to Everlasting Success
• How Will the United States Finance the Biggest Deficit of All Time?
• Consumer Spending Rises
• The Solution to a Depression is a Depression

And so we turn to our Daily Reckoning, as we do everyday. Our goal is not to make readers rich. Nor is it to win a Pulitzer Prize for financial journalism. No, we set much lower targets. We just don't want the cleaning lady to be embarrassed to work for us. Even in that, we frequently fall short...

"Mr. Bonner... I spotted another split infinitive in the DR..." said Clara.

"I'm sorry," was our response. "I will try to always do better."

(Mistakes are inevitable. But, rather than try to catch them all, it's probably easier to get a new cleaning lady. One who is not an intellectual.)

In the meantime, what a recovery! If the economy keeps recovering like this we'll soon all be busted...

House sales are falling...unemployment is rising...and people are getting poorer!

The Dow rallied a piddly 23 points yesterday. Oil is selling for less than $75 this morning. Stocks are in trouble. As we said yesterday, this could be the beginning of the end for this bear market. We've seen the first leg down. We've seen the rally. We're ready for the next big plunge.

Yesterday, the latest numbers on existing house sales for December came out. They were disappointing - nearly 17% lower than the year before.

Unemployment is still rising, as near as we can determine. It is rising for two reasons. Because we are in a depression. And, because the feds are trying to 'do something about it.'

In this regard, we refer to three different phenomena. They are inter- related...they all show the same thing: an economy going downhill.

First, initial jobless claims surged last week...with 36,000 more claimants.

This also from Bloomberg:

"Employment dropped in 39 US states in December, seven more than in the prior month, indicating job losses were widespread.

"Payrolls in California showed the biggest decline, falling by 38,800 last month, according to figures issued today by the Labor Department in Washington. Texas followed with a 23,900 decline and Ohio was next with a 16,700 drop.

"With the national unemployment rate projected to average 10 percent this year, state budgets may continue to be strained by limited tax revenue and jobless insurance payments. While the pace of firings has eased over the last year, the time it is taking to find a job rose to a record 29.1 weeks in December.

"Employment is 'still very weak, which is why we think the unemployment rate is going to continue to rise,' Marisa Di Natale, a director at Moody's Economy.com in West Chester, Pennsylvania, said before the report. 'There are some states that are in pretty big trouble, fiscally speaking. 2010 is not going to be a good year.'

"The jobless rate in the US held at 10 percent in December, the Labor Department said on Jan. 8. A jump in the number of discouraged workers leaving the labor market kept the rate from rising...

"Employment in all 50 states dropped in 2009, with Wyoming, Nevada, Michigan and Arizona showing the biggest percentage decreases. The District of Columbia gained jobs, adding 6,200 in the 12 months to December.

"Nevada and West Virginia had the biggest increase in joblessness among states last year, each climbing 4.6 percentage points. Alabama was next with a 4.5-point gain, followed by Michigan's 4.4-point increase."

An analysis done by the AP shows that stimulus spending has no effect on employment. The AP looked at counties that got a lot of stimulus money to repair roads and bridges, and those that didn't. They found no connection between the spending and employment rates.

Even we are a bit surprised. We knew that stimulus spending was a waste of money. But we figured the feds could force a little extra hiring here and there if they really put their minds to it. Apparently not... At least not on the scale of the present stimulus spending program.

Stating the finding a bit more broadly: stimulus spending doesn't really stimulate at all. In fact, it retards. And then it debilitates...by taking capital out of productive uses and squandering it. Instead of leaving the private sector alone so that it can find new ways to put resources to work, the feds take the resources and waste them in the old-fashioned, unproductive ways. Result: money spent; no stimulus; people poorer.

Second, the Brookings Institution came out with a warning yesterday. It said 30% of the nation was either in poverty already or headed to it. The US is becoming like a 'developing nation,' said the report, with 39.1 million people living in poverty.

Many cities have already reached the 30% poverty rate - including Cleveland, Detroit, Youngstown, Buffalo, Syracuse, Dayton and Hartford, Connecticut. But poverty is increasing fastest in the suburbs, says the report.

We add a footnote. About 40 million Americans are also living on food stamps - a new record.

Third, while the feds take money away from productive enterprises and honest savers, they also encourage people NOT to work. How is this possible? Alan Reynolds, writing in The New York Post last month, explained how the feds had probably added two points to the unemployment rate simply by stretching unemployment benefits from the traditional 26 weeks to the current 79 weeks.

"When you subsidize something, you get more of it..." he writes.

That is how the feds operate. They punish success and reward failure. If a man is lucky enough to get a good job and earn a lot of money, the feds tax it away from him. If he fails to find a job, on the other hand, they give him money. The longer he stays unemployed, the more money they give him.

If a banker runs his bank well, he gets nothing but trouble from the feds...paperwork, bureaucracy, pettifogging regulations. But if he runs it badly, he gets billions of dollars worth of bailouts.

If an automaker takes the best business in the world and runs it into the ground, he gets the support of the federal government. If he runs his business well, he gets nothing but headaches.

The feds' recovery program pays for failure. Naturally, they get a lot of it.

Breaking News: Expert researcher reveals urgent, once-in-a-generation market opportunity...

Ben Bernanke seems to be sailing to another term as the nation's chief central banker. Obama gave him a big push. When it looked like that might not be enough, Tim Geithner tried blackmail.

Failure to return Bernanke to the Fed could cause market instability, he told the Senators.

These poor dumbos...all of them. Larry Summers, Ben Bernanke, Tim Geither...Barack Obama...and all the House and the Senate (the only exception we know of is our old friend Ron Paul)...

..None of them has a clue. They warned Congress in September '09 that the world would come to an end unless Wall Street was bailed out. They got their way. Wall Street was bailed out; and the world didn't come to an end. So, they must have been right about it.

None of them knows what is going on. And none of them has any interest in finding out. When it comes to the feds, ignorance pays.

Who wants a Fed chief who admits the truth?

"I'm sorry," Bernanke should tell a televised joint session of Congress. "Our economy is de-leveraging. There is nothing we can do except get out of the way.

"If we bail out failed enterprises, we will have more failed enterprises.

"If we pay people not to work, we will have more people not working.

"If we provide more credit, we will have even more debt.

"If the government uses more resources, the private sector will have fewer resources.

"Forget it. There's no way out. So, let's stop all this gimcrackery. Let's back off and let the markets do their work: let failed companies go broke...let homeowners who can't pay their mortgages lose their houses...let speculators lose money...let the chips fall where they may, so that the next generation of entrepreneurs can pick them up and make something with them. Let it be."

Mr. Bernanke would be lucky to make it out of the Capitol alive.

Bill Bonner
for The Daily Reckoning Australia

• The Scam of Ever-Rising House Prices
• US Has Highest Unemployment Rate of All Major Economies
• Consumer Prices are Rising at About 10% Per Year
• The Story Behind China Dumping its US Treasury Debt
• US Economy is Some 11 Million Jobs Short of Full Employment

The bad labor news last week didn't seem to bother investors. They're all monetarists, optimists, or delusionists. They figure that the jobs picture will keep the Fed from raising rates...and that the low interest rates will keep stocks moving up.

They are wrong. Well, they are right about the first part and wrong about the second. The Fed will not raise rates anytime soon. But it takes more than low rates to create a durable boom on Wall Street. It takes earnings growth.

Today's prices imply strong earnings growth in the next 12-24 months. But it's not likely to happen. Ambrose Evans-Pritchard:

"Realtytrac says defaults and repossessions have been running at over 300,000 a month since February. One million American families lost their homes in the fourth quarter. Moody's Economy.com expects another 2.4m homes to go this year. Taken together, this looks awfully like Steinbeck's Grapes of Wrath.

"Judges are finding ways to block evictions. One magistrate in Minnesota halted a case calling the creditor 'harsh, repugnant, shocking and repulsive'. We are not far from a de facto moratorium in some areas.

"This is how it ended between 1932 and 1934, when half the US states declared moratoria or 'Farm Holidays'. Such flexibility innoculated America's democracy against the appeal of Red Unions and Coughlin Fascists. The home siezures are occurring despite frantic efforts by the Obama administration to delay the process.

"...It takes heroic naivety to think the US housing market has turned the corner (apologies to Goldman Sachs, as always). The fuse has yet to detonate on the next mortgage bomb, $134bn (£83bn) of 'option ARM' contracts due to reset violently upwards this year and next.

"US house prices have eked out five months of gains on the Case-Shiller index, but momentum stalled in October in half the cities even before the latest surge of 40 basis points in mortgage rates. Karl Case (of the index) says prices may sink another 15pc. 'If the 2008 and 2009 loans go bad, then we're back where we were before - in a nightmare.'

"David Rosenberg from Gluskin Sheff said it is remarkable how little traction has been achieved by zero rates and the greatest fiscal blitz of all time. The US economy grew at a 2.2pc rate in the third quarter (entirely due to Obama stimulus). This compares to an average of 7.3pc in the first quarter of every recovery since the Second World War."

You have to like automobiles...and traffic. We spent yesterday taking Edward back and forth to school. Then, we got stuck in a traffic jam on the beltway coming back from shopping.

It didn't help that there is road construction going on everywhere. A sign tells us that this is thanks to the stimulus program. How nice. Taxpayers from Maine and Montana are paying to pave the roads in Montgomery County, Maryland...where practically everyone works for the government and earns more than the taxpayers who support them.

It didn't help either that local road crews were out spreading more salt - in anticipation of another snow storm; one that never came. The roads are white - with sodium chloride. There's so much of it on the highways our blood pressure rises just driving to work.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Salt vs. Snowflakes
• Fannie and Freddie Say Goodbye to Veto
• Between What Bond Investors Stand to Gain in Yield and What They Stand to Lose from Inflation
• People Without Jobs Can’t Make Mortgage Payments
• America’s Service Industry is responsible for Low Wages

Meanwhile, celebrated short-seller Jim Chanos says China is going to blow up. It's going to be "Dubai times 1,000," he says.

Our old friend Jim Rogers disagrees. He thinks Chanos hasn't looked long enough or deeply enough into the China story. He thinks China is a buy.

And what do we think?

We don't think. We listen:

"Something like 50% of Chinese economic growth - if you can believe the numbers - is based on capital investment," said a dinner companion last week. "You can't invest that kind of money without making some pretty major mistakes."

If we were forced to bet on it...we'd bet that Chanos is right. We don't know anything about China or the Chinese economy. But you don't go from third-world communist hellhole to the world's second major economy without some serious bust-ups...especially when the communists are still in control.

Barely had we touched down in the USA than we were invited to a dinner party in Georgetown. In keeping with the Chatham House Rules, we won't mention any names, but we were in distinguished company. These were America's elite of movers and shakers, ambassadors, lawyers, policymakers, people who reflect and shape the opinions - and actions - of the US empire.

We were invited to answer questions; instead, we asked them.

We began by mentioning the failure of the economics profession. Never had an unarmed group done more damage to the wealth of a society, we suggested. Economists helped create a huge bubble, ignored it until it blew up, and then gave the wrong advice about how to fix it. Bailouts and boondoggles were all they had to offer.

But wait a minute, said a fellow diner: 'I'm an economist...we couldn't let the whole banking system collapse.'

"Why not?" we asked.

'Because unemployment would go up to 14% or more...'

"How do you know what the proper rate of employment should be?" we wanted to know.

'But you can't just ignore people when they are out of work...and you can't ignore an economy when it goes into a depression, can you?'

"Why not?" we repeated our first question.

What we notice in our brush with America's intellectual and political elite is that they are very smart, very well informed, but too busy to stop and think.

They are thinkers. They are always thinking about what to do. But they cannot afford to think radically...about why they should do anything at all. If they did, they would be as marginalized as we are... How much more fun it must be to be at the center of power...pulling the levers...turning the knobs...making the world a better place!

The presumption of all elites is that they can do a better job of running things than people who are less well educated, less informed, or less intelligent. In a sense, this is obviously true. In the administration of commonly held assets, for example - such as a municipal sewage-treatment plant...or an art collection - a person with taste, culture and education is likely to do a better job than a numbskull. (We admit that even this is a dubious assertion...but we will presume it is true for the sake of this argument...)

But the elites go a major step further...they claim to be able to do a better job of administering privately held assets too...things that belong to other people.

Take the Cash for Clunker program. Auto sales went down. But so what? How many cars SHOULD be bought and sold? Nobody knows. And it's really not for anyone to say...other than the buyers and sellers themselves. But the elite think they know better.

The fellow with an old pick-up truck may have judged his truck good for another six months of service. But with the lure of a federal bribe before him, he junked the truck six months early. Any sensible person can see that this is a waste. A valuable asset has been lost - six months of truck service.

But the elite economist thinks he has saved the auto industry. Because the "demand for trucks has been stimulated." Jobs have been saved. Detroit has been given a boost.

What kind of nonsense is this? Not only have useful resources been sent to the scrap heap prematurely, but the auto industry has been given a bum steer, too. Resources from all over the economy - steel, oil, labor, electronics - have been diverted to the auto industry, on the basis of 'demand' that only exists because of federal money. The laid- off autoworker is a victim too. He might have been considering turning to another trade...instead, called back to work by the Cash for Clunkers program, he shelves his plans for retraining and relocation. He thinks Detroit is making a comeback. How disappointed he will be when the phony demand disappears!

And where did the federal money come from? It had to come from somewhere. In the event, it was borrowed from lenders who would otherwise have lent it to someone else. We don't know what the other borrower would have done with it, but no matter what it was, it could be expected to produce a net benefit, one way or another, to the economy.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• A Period of Positive Collapse
• Water Usage by Big Companies
• Tackling Economic Clouds
• Dumb Money Eyes Stock Market While Smart Money Watches Economy
• Bill Bonner On Chinese Trucks