“Say goodbye to your money!”…bursting bubbles always lead to the same things…Inflation: Enemy Number Two…what kind of world would it be if people always behaved sensibly? Sicking “the fuzz” on terrorism…the bubble that always ends in the perp walk…and more!

All bubbles end in busts…and the perp walk.

Two hedge fund managers were arrested yesterday. It was claimed that the two Bear Stearns boys deceived customers.

Oh stop it! We’re going to break a rib laughing….

Deceived customers? What is a hedge fund anyway? It’s a way for Wall Street to take money from investors who can’t do math. There’s no deception required. In fact, the funds’ names – High Grade Structured Credit Strategies Fund and High Grade Structured Credit Strategies Enhanced Leverage Fund – told investors all they needed to know. They practically screamed out: ‘SAY GOODBYE TO YOUR MONEY…IF NOT NOW, LATER.’

So, imagine that you have money invested in the fund that advertises itself as offering “enhanced leverage” from “structured credit strategies.” Now, imagine that you read in the paper that houses are going down in price…and that subprime mortgages are going belly up. Couldn’t you put two and two together? Well…duh… but that’s just it, people who invest in hedge funds can’t do math. The managers didn’t have to deceive them. They just had to keep their mouths shut…which they did.

But this is the way bubbles end…in losses…in anger…and in jail. The losers always think someone else is to blame. It’s not long before they have a CEO, a speculator, or a fund manager mounting the scaffold.

Let’s leave that thought on the shelf and get on with our reckoning.

Oil lost $4 yesterday. The Dow rose 34 points. The euro slipped a little. No biggie.

But look at this: “Inflation now enemy #1 for the Fed,” says the Wall Street Journal. This sort of thinking sent the price of gold up $10 yesterday; it’s now back over the $900 level. And one of the key fellows at Schroder Investment Management told a crowd in Hong Kong that he thought gold could go to $5,000 before this run of inflation is over.

$5,000? Who knows? But, the poor saps at the WSJ are missing the point. No central bank keeps rates 2.2% below the level of consumer price inflation if it is really fighting inflation. Enemy Numero Ono? What are they thinking? Why are all the Fed’s guns facing deflation, not inflation? Sure, there’s been some blabbing about turning around…about switching sides in the war between inflation and deflation. But so far, it’s just talk.

Talk is cheap. It’s action that is dear. And the action the Fed needs to take – raising rates – will be so potentially costly for the lame U.S. economy that Bernanke and Co. are afraid to do it. They’re hoping inflation will go away so they can continue the battle against the slump, without having to worry about their unprotected flanks. Most likely, they will make a gesture towards raising rates – perhaps a quarter of a point. But then, when the mob starts howling for his head, Ben Bernanke will drop them again.

Henry Paulson has been gurgling about a strong dollar. Yesterday, he gave voice to a contradictory notion – that the Chinese should let their currency rise (and the dollar fall).

The problem for the Chinese is that they have too many dollars, furnished courtesy of the Fed, while Americans have too few. In the United States, the average household barely has enough dollars to fill its gas tank and pay its bills. But the Middle Kingdom is flooded with them.

If you don’t watch out, you’re going to drown in them, said Paulson – or words to that effect. China’s economy continues floating higher and higher. But all these extra dollars are pushing up wages and prices as well as the economy.

And then, wouldn’t you know it, Chinese export prices go up too. And pretty soon, prices are up all over the world.

Which is why the WSJ thinks it’s the top problem for the Fed too. Of course, it is a problem. But with the official CPI at 4.2% it’s not enemy number one. Maybe it’s Enemy Number Two. Most likely, it will stay there for a while longer. We still haven’t seen a big drop in commercial property…or in consumer spending. Those are probably still ahead…and will give the Fed a reason to continue blasting away at a deflationary slump. Consumer prices will continue to rise, too. Eventually, they will become so high that inflation really does become Enemy Number One.

By that time, the price of gold could be $500 higher.

*** An empire is, fundamentally, in the business of providing protection. People in America applauded when the Soviet Union collapsed and China took the capitalist road…but it practically put them out of business. There was nothing to provide protection against.

The sensible thing for the United States to do, following the fall of its one and only major enemy, would have been to cut the defense budget down to a nub…and invest the money in infrastructure and capital improvements, so Americans would be able to compete on better terms with the rising economies of their former enemies. It was obvious that with billions of people entering the modern economy for the first time, the world was beginning a new, more competitive phase of development…and that without huge capital investment, labor rates for marginally skilled workers were doomed to fall.

But what kind of world would it be if people always behaved sensibly? Instead, it was party time in the U.S. of A. Americans went on a binge of spending, borrowing and soft-headed thinking. Colleges switched from teaching engineering to letting students emote on subjects such as gender and racial equality. The leading profit makers switched from manufacturing to finance…from making things to lending money…from Detroit to Wall Street. New regulations imposed higher operating costs…and more lawyers and more delays. And lobbyists got billions in special favors.

No lobbyists were as successful at squeezing the public tube as those who work for the defense industry. People come to believe what they must believe when they must believe it. The United States is an imperial power with one major leading industry: defense. But with no enemies capable of inflicting real damage to the country, the defense industry had to invent one: terrorism…and the people had to believe it.

Readers typically want to argue this point. “What about 9/11?” they ask.

Of course, terrorists always pose a danger to individuals. And if they are daring and determined enough, they pose a danger to many individuals. But they pose no real danger to the state…and none to the Pentagon. You could put all the world’s terrorists together in a single army…they would still stand no chance whatsoever of defeating the United States of America.

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