In this parallel reality, U.S. Federal Reserve Chairman Ben S. Bernanke has just rung the loudest bell ever heard in the foreign-exchange and government-debt markets. Investors who ignore the clanging do so at their own peril. The bell’s reverberations will be felt by everyday Americans, whose lives are about to change in ways few can imagine.

While nearly every facet of America’s economy has been devastated over the past six months, our national currency has thus far skipped through the carnage with nary a scratch. Ironically, the U.S dollar has been the beneficiary of the very global economic crisis that the United States set in motion. As a result, our economy has thus far been spared the full force of the storm.

Following its policymaking meeting last week, the Fed finally made clear what should have been obvious for some time: The only weapon that the U.S. central bank is willing to use to fight the economic downturn is a continuing torrent of pure, undiluted, inflation. The announcement should be seen as a game changer that redirects the fury of the financial storm directly onto our shores.

In its statement, the Fed announced its intention to purchase an additional $1 trillion worth of U.S. Treasury and agency debt. The purchases, of course, will be made with money created out of thin air through the government’s printing presses. Few can doubt that it will persist with these operations until the economy returns to its former health. Whether this can ever be accomplished with a printing press alone has never been seriously considered. Bernanke himself admits that we are in uncharted waters, with no map or compass, just simply a hope that more dollars are the answer.

Rather than solving our problems, more inflation will only add to the crisis. Falling asset prices, the credit crunch, declining consumer spending, bankruptcies, foreclosures, and layoffs are all part of the necessary rebalancing of our economy. These wrenching movements, however painful, are the market’s attempts to resolve the serious problems at the root of our bubble economy. Attempts to literally paper-over these problems will lead to disaster.

Now that the Fed has recklessly shown its hand, the mad dash to get out of U.S. Treasuries and dollars should not be far off. The more the Fed prints to buy bonds the less the dollar is worth. Holders of our debt (read China and Japan) understand this dynamic. We must expect that they will not only refuse to buy new bonds, but they will look to unload those bonds they already own.

Under normal circumstances, if creditors grew concerned that inflation was eating into their returns, the Fed would raise interest rates to entice them to buy. However, the Fed will avoid this course of action as it fears higher rates are too heavy a burden for our debt-laden economy to bear. To maintain artificially low rates, the Fed will be forced to purchase trillions more debt than it expects to as it becomes the only buyer in a seller’s market.

Just last week, Chinese Premier Wen Jiabao voiced concern about his country’s massive investments in U.S. government debt. In the most unequivocal statement yet by the Chinese leadership on this issue, Wen made it plain that he was concerned with depreciation, not default. With his fears now officially confirmed by the Fed statement, we must wonder when the Chinese will finally change course.

There is a growing consensus that if China no longer wants to buy our bonds, we can simply print the money and buy them ourselves. This naïve view fails to consider the consequences implicit in such a change. When the Treasury sells bonds to China, no new dollars are printed. Instead, China prints yuan, which it then uses to buy Treasuries. This effectively allows America to export its inflation to China. However, now that we will be printing the money ourselves, the full inflationary impact will fall directly on us.

With such a policy in place, America has now become a banana republic. It won’t be too long before our living standards reflect our new status. Got Gold?

[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a well-known author and commentator, and is a periodic contributor to Money Morning. Schiff is the author of two New York Times best sellers: "The Little Book of Bull Moves in Bear Markets,"and " Crash Proof: How to Profit from the Coming Economic Collapse"." For a more-detailed analysis of the nation's financial problems, and the inherent dangers that these problems pose for both the U.S. economy and for dollar-denominated investments, click here to download Euro Pacific's new financial-research report, "The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities."

In the midst of an ongoing financial crisis that's eradicated trillions of dollars in shareholder wealth, the profit search facing U.S. investors is tougher than ever. The uncertainty surrounding the economic-stimulus and banking-bailout plans isn't helping.  But a special new offer from Money Morning is a two-way win for investors: A free report provides insights into the threats those plans pose, while our monthly newsletter, The Money Map Report, consistently spotlights some of the hard-to-find but potentially lucrative profit plays that remain. Investors who subscribe to the Money Map Report can obtain a complimentary copy of Schiff's best seller, "Crash Proof," in which he details the causes of the housing bubble and financial-system collapse, and tells investors how to dodge losses from the problems that are still to come. To read our free report, and to find out more about this special offer, please click here .]

Source: Will the Bailouts Transform Us from Global Superpower to Banana Republic?

And that figure, incidentally, doesn’t include the additional losses from secondary-prime mortgage loans, auto loans, credit card balances, student loans and the other credit-related flotsam and jetsam floating around in the debt markets.

That suggests that the hundreds of billions of dollars in emergency capital infusions from the world’s central bankers we’ve seen to date may only be a fraction of what’s ultimately needed by the time fully leveraged figures are thrown into the mix.

Second, liquidity conditions now may actually be worse than when the entire credit-crisis mess began to unravel this time last year. For example, the benchmark London Interbank Offered Rate (LIBOR) remains higher than so-called “policy rates” and U.S. Treasuries of comparable maturities.

This suggests that banks still don’t trust each other and therefore are keeping so-called “Interbank” borrowing rates high in order to reflect what they perceive to be the added risk of doing business. We’ve been warning investors to watch out for this since as far back as April, and have generally been preaching caution since the credit crisis began last year.

In other words, the fact that Libor-Treasury spreads are wider today than they were a year ago suggests that the banks really don’t know who continues to hold the toxic debt instruments the entire world has come to fear – despite a recent earnings parade of CEOs making claims to the contrary.

The upshot: Many institutions are hoarding cash – something you’d hardly expect to see if the credit crisis were really on the mend.

Third, judging from recent reports, it’s beginning to dawn on financial regulators that this crisis was never about a lack of liquidity in the first place, which is something I suggested in an open letter to U.S. Federal Reserve Chairman Ben S. Bernanke some time ago.

Instead, this crisis is about three things:

• Too much liquidity.
• Fundamental structural problems in the credit industry, including the almost-total lack of regulation.
• And the lack of transparency of complex financial instruments for which there is no public market, making them tough to value and nearly impossible to trade.

It is becoming clearer by the day that – partly because of these three factors – a good deal of money has been made fraudulently, if not illegally.

Granted recent changes surrounding the “mark-to-market” accounting of so-called “Level 3″ assets are a step in the right direction. But what few people realize is that, in the short-term, these new requirements could involve the immediate recognition of even larger losses than we’ve seen to date.

The reason is that many of the firms involved – think Merrill Lynch & Co. Inc. (MER), Lehman Brothers Holdings Inc. (LEH) and Citigroup Inc. (C), for example – will no longer be able to hide their losses in Level 3 assets, as they have in the past.

As you might expect, there’s a counterargument to this, and it’s a highly popular one on Wall Street – especially inside the CEO set, whose members desperately want to stop the financial hemorrhaging their firms are enduring. They claim they’re “selling” risky assets and “de-leveraging” their balance sheets.

But here’s what they are not telling you.

Even though these folks are technically “selling” assets – particularly the distressed “Level 3″ assets I mentioned a bit earlier – what they are really doing is assigning the upside to hedge funds, private equity firms, and sovereign wealth funds in exchange for cash.

And here’s the kicker: The banks actually are holding onto the downside liability in the event the underlying securities go bad. That brings us back to the start of this commentary, when I said that I expect more securities to go bad.

No matter how you look at it, these financial institutions are playing a vicious shell game, hoping all the while that they’re not the loser who is taken to the cleaners when he picks up the wrong shell.

Where this goes from bad to worse is that at the same time they’re playing more fancy accounting tricks, these firms continue to pony up to the Fed’s private backdoor lending window for sweetheart financing. After all, they can’t get the financing anywhere else.

That means that every taxpayer in this country is involuntarily being put in the bailout business.

As for whether or not we’re near the end of the credit crisis as a whole, it depends on whom you ask.

When this crisis started a year ago, I was asked a similar question and answered it by saying that we would not even begin to approach the end of the line until the total losses exceeded $1 trillion.

My audience chuckled politely.

Fast-forward 12 months, and nobody’s laughing anymore – especially when I say that I’m now raising my industry loss estimate to nearly $2 trillion.

Increasingly, other analysts are embracing a similar viewpoint. UBS AG (UBS) raised its estimate of the total cost of the credit crisis to $600 billion, while noted hedge fund manager John Paulson suggested $1.3 trillion is not unthinkable. Meanwhile, in a report issued last May, the International Monetary Fund (IMF) projected the bailout costs at $1 trillion.

All of this leads us to a single conclusion: At least for now, this is a “recovery” in name only.

Source: Three Ways to Know When the Credit Crisis Hits Bottom

“I’ve already called this credit crunch, ‘the worst financial crisis since the Great Depression’…and unfortunately, we’re not through it yet” says Eric Roseman.

It’s true the worst of this credit storm has probably passed. But banks, companies and individual investors are still facing funding pressures. That tells me the absolute bottom of this crisis has yet to arrive.

The highest estimates I’ve heard say it will take US$1.7 trillion to clean-up this credit crisis. The more conservative projections allude to a US$500 billion cleaning bill (remember when half a trillion dollars seemed like a lot of money?).

Either way, it’s not time to buy aggressively into stocks.

But investment-grade bonds are starting to look increasingly attractive – particularly as credit spreads start to stabilize among highly-rated corporate debt instruments and Treasury bonds. But it’s still too early for bargain-hunting in equities and riskier debt markets.

The Smart Money Isn’t Following the
Sucker Stock Rallies

This morning’s edition of the Wall Street Journal points to lingering concerns in debt markets. According to the Journal, credit spreads for higher risk bonds, short-term inter-bank lending rates and investment-grade corporate financing remain under severe pressure.

Stocks might have mustered a big rally yesterday, but the smart money in credit markets is showing a very different picture on the state of the American economy.

How will investors know it’s time to load-up on distressed common stocks again? Is there a set of indicators that allow you to measure credit stress?

As the bottom of this bear market eventually arrives, look to credit markets for signals that it’s time to resume your buying. Bonds and credit spreads will provide a far more accurate gauge to global investors than stocks, which tend to harbor false recoveries or “sucker” rallies.

Yield-Curve Inversion Warning in 2006-2007

Back in 2006, the Treasury yield curve turned negative, and accurately forecast an economic recession. Back then, I was writing about it - warning about this dangerous anomaly.

Today, it’s still my opinion that bonds represent the “smart money” in the financial markets. Historically, bonds have accurately predicted economic recessions more often than not.

An inverted or negative yield-curve occurs when short-term interest rates yield more than long-term rates. That’s an anomaly in fixed-income markets that has historically preceded a slowdown or an economic recession about 12 months later.

At the time, most analysts refuted this price action, but it still proved incredibly accurate. By July 2007, the credit markets had begun to unwind and stocks tanked, finally hitting bear market territory for the first time since 2002.

While Treasury bond inversion accurately forecasted trouble ahead, that wasn’t the case for the Dow or the S&P 500 Index.

In stark contrast, the S&P 500 Index in mid-2006 was still in bull market mode, defying the repeated warnings from the Treasury market as yield inversion grew louder. And most high-risk credit markets, namely high-yield or junk bonds, also continued to race higher even as the Treasury market began predicting trouble.

The Credit Crisis Check-List

I thought I’d give you a little insight to how I gauge the markets. These are the indicators I’ve been watching like a hawk for years. And today, I’m using this checklist to predict when the current credit crisis will bottom. More importantly, I’ve got my eye on these indicators so I know exactly when I can re-enter the stock market. You can do the same.

I’ll elaborate on each of these indicators so you can better identify what to follow and eventually, call your broker and start loading-up on equities again!

• LIBOR and SWAP rates
• Credit spreads
• Mortgage-backed securities
• Junk bond defaults
• Credit hedge fund failures

LIBOR and EURO LIBOR are important short-term overnight lending rates. LIBOR or the London Interbank Offered Rate has historically traded slightly above the official Federal Funds rate. Euro LIBOR has also historically traded just above the European Central Bank’s official base rate since the currency was introduced in 1999.

The SWAP Rate -
A Sign That Banks Aren’t Confident to Lend

The difference between LIBOR and overnight interest rates set by central banks is called the SWAP rate. This spread number must relax or narrow before credit markets get a “green” light to unclog and start lending as usual again.

But since last summer when sub-prime began to boil, overnight lending rates have skyrocketed. Despite the Federal Reserve’s best efforts to lubricate the wheels of the funding markets since last summer, inter-bank lending rates remain high. And institutions are reluctant to commit overnight funds to one another.

This lack of confidence among banks in the United States, Canada and Europe, is spreading to Asia. As banks grow wary of lending to one another and question inter-bank collateral, the cost of funds increases exponentially. And that slows economic growth.

LIBOR Rates Say Banks Are Holding onto Their Cash -
A Sign the Credit Crisis Is Still With Us

From its high last fall, U.S. dollar LIBOR SWAP rates managed to decline before Christmas. That was after the Fed and other central banks injected gobs of credit to stabilize the financial system.

But since March, LIBOR SWAPS and its European counterpart, Euro LIBOR SWAPS, have jumped. This is an important signal that the credit crisis is not over. Until LIBOR SWAP rates decline and return to normal spreads above central bank monetary targets, the crisis continues.

CREDIT SPREADS are another indicator worth watching. The spread between risk-free Treasury debt and other bonds like corporate debt and junk bonds is called a “credit spread.”

When the economy is strong and deal-flow is rampant, credit spreads will narrow. That happened as we headed into 2007 last year. Junk bonds, which are below investment-grade credits, saw their yields hit historic lows versus Treasury bonds last spring. That was just ahead of the July sub-prime blow-up. At the time, high-yield bonds paid under two hundred basis points (2%) above T-bonds – unbelievably low.

Today, that spread is just below 10%. And it’s likely it will rise further as default rates climb in a recessionary economy. Until credit spreads for riskier bonds begin to tighten or narrow significantly, the economy remains on the rocks.

Those Mortgage-Backed Securities
We’re All So Fond Of

MORTGAGE-BACKED SECURITIES encompass a wide spectrum of instruments ranging from synthetic illiquid CDOs or collateralized debt obligations to bonds issued by government agencies like Fannie Mae (FNMA) and Freddie Mac (FHLMC).

You’ll be able to tell when stability returns to the mortgage-backed area by watching the mortgage-backed derivatives and the more conservative mortgage bonds guaranteed by FNMA. When both of these numbers bottom, that’s a sign this credit crunch is easing.

The good news is that PIMCO’s Bill Gross, the world’s savviest bond investor, has loaded-up on 30-year mortgage bonds guaranteed by Fannie Mae. These bonds yield almost 2% more than Treasury bonds. That’s a bullish sign that investors are returning to the safest segment of the tattered mortgage market.

However, the mortgage-backed market still has a long way to recover. In all likelihood, the CDO market and other synthetics tied to mortgages will probably never trade at par-value again. But at some point, deep value investors will start buying some of the more liquid CDOs, and that will point to a bottom in this market.

Sometimes It Pays to Watch the Junk

JUNK BOND DEFAULTS typically hit a high in excess of 5% of outstanding instruments during a recession.

At the moment, the junk bond default rate is under 2%. That suggests many more financially leveraged and indebted companies will head into bankruptcy or credit default. I would have to see a much higher default rate among American high-yield or junk bond companies before turning bullish on the stock market.

CREDIT HEDGE FUNDS represent the largest segment of total hedge fund assets, now an estimated US$2 trillion. Combined with leverage, credit hedge funds are the dangerous pariahs of the investment world in 2008 as more of their investors scramble to redeem assets.

Many credit hedge funds have already collapsed or have been liquidated since 2007. As assets are liquidated to meet growing redemptions, hedge funds must unwind leverage and ultimately, abandon many positions in the credit markets that are illiquid. This will snowball into a major disaster for leveraged hedge funds in asset-backed, distressed and event-driven hedge fund strategies.

The end of the credit crisis will likely coincide with a major blow-up at one of the largest credit hedge funds in the world. To date, the failures have mostly represented second-tier or smaller industry players.

Hang In There, This Will Pass

The above credit market check list is by no means absolute. But if you’re looking for a bottom in stocks, these numbers can help you gauge when it’s time to buy again. And of course, I’ll continue to watch all these indicators for signs of a bottom. And I’ll let you know the moment I see it coming here in the A-Letter.

This credit crisis will eventually pass. The worst is probably behind us for most segments of the debt markets but danger still lurks for equity investors. Tread carefully and heed the signs of credit, not stocks, for a true bear market bottom.

ERIC ROSEMAN, Investment Director

EDITOR’S NOTE: As Eric watches for signs this credit crunch is easing, a related crisis is emerging worldwide. It’s a dangerous cocktail of worldwide food and fuel inflation. This disastrous combination has already sent commodity prices sky-high and sparked protests, hoarding, strikes and deadly riots the globe over. Today is your last day to find out FREE of charge exactly why these record-high food prices will continue to rise – and how to use that information to make up to 910% on these soaring commodities. You have until MIDNIGHT tonight. Click here.