And with good reason. The United States has a bigger and more-troubled financial sector than most countries. It also has a bigger overhang from the housing bubble, has a bigger balance-of-payments deficit and has a budget deficit that’s fat enough to stall the recovery.

It would be nice to have an economic recovery to invest in that didn’t have all of these problems.

Truth be told, such an investment play does exist. What’s more, the market I have in mind is advanced enough for us to invest in it without having to go through all the rigmarole of American Depository Receipt (ADR) investing. Nor will you have to make a potentially risky foray out onto some foreign stock exchange to buy the shares, because they are almost all listed here.

The country I’m talking about is Canada. Think of it as being like home – but without the problems that our home market (the United States) currently suffers from.

Our Healthy Neighbor to the North

When the recession struck, Canada was hit by it quite badly, but for different reasons from its southern neighbor. The Canadian housing market was nowhere near as overheated as its U.S. counterpart. So Canada’s housing downturn wasn’t as deep.

And what about the banking systems? To be sure, Canadian banks received a bailout, but it was less than $20 billion in total. Compare that to the veritable alphabet soup of U.S. bailout programs ranging from “TARP” and “TALF” that have injected more than $2 trillion into the U.S. financial system.

On the other hand, natural resources prices crashed last autumn, which had a major effect on Canada’s resource-based economy. A number of large projects in the Athabasca Tar Sands region were cancelled, for example – since this region has oil reserves around the size of the entire Middle East, its development is crucial to Canada’s future.

The “loonie,” Canada’s currency, declined from around “parity” to the U.S. dollar to an exchange ratio of C$1.30=$1 U.S. In effect, this was a “flight to safety” into the dollar and U.S. Treasuries. And it affected Canada as it did other countries.

In 2009, however, Canada and the United States have traveled down totally different paths. Canada did very little “stimulus,” so its state budget is in much better shape. The deficit for the 2009-2010 fiscal year $53 billion (C$56 billion) is only about 4% of gross domestic product (GDP). For the 2010-2011 fiscal year, the deficit is expected to be about $42 billion (C$45 billion), or 3.2% of GDP.

Energy Powers the Rally

The bounce in natural resources prices has really helped power up the rebound of Canada’s market.

Investment in the tar-sands region has picked up again, with a big merger between the two largest tar-sands-extraction companies: Suncor Energy Inc. (NYSE: SU) and Petro-Canada. The rising gold price hasn’t hurt either – mines are appearing all over the place! All this new activity has made the loonie bounce, so it’s back to about C$1.07=$1. While interest rates are as low as the United States, the Bank of Canada hasn’t done much “quantitative easing,” meaning that inflation isn’t too much of a worry.

The strong loonie helps here, too.

Canada seems to be recovering nicely. Its index of leading indicators jumped 1.1% in August, while manufacturing sales grew 5.5% in July. The country presently runs a modest current account deficit, but it’s only 2% of GDP. That’s much lower than even the current U.S. deficit, let alone that of 2007. It had a little more public debt than the United States in 2008, but given current U.S. deficits, those two lines almost certainly have crossed by now.

There are two caveats. The first is an obvious one: If commodity prices crash to earth, Canada will have some difficulty because commodities are a large part of its economy. Personally, I don’t see that happening. It’s notable that PetroChina Co. Ltd. (NYSE ADR: PTR) has just invested $1.7 billion in a Canadian tar sands project, so China must not think so, either.

The other risk is political. The current minority Conservative government of Stephen Harper has done a good job, but the opposition Liberals have withdrawn their parliamentary support. That means there may be an election this autumn. A Liberal majority government would be no disaster. They might be a bit sticky about oil-drilling permits, but would not otherwise rock the boat.

However, a Liberal coalition with the leftist New Democrats could push public spending and the deficit up, and there’s no guarantee against that. (One of the problems with multi-party systems like Canada’s is there is an almost infinite variety of possible governments after each election, some of which can be fairly alarming from a business perspective.)

However, Canadian elections are a much smaller risk than you get in most countries, and the commodity/oil price crash, if it happened, would help the U.S. economy and, presumably, your U.S. portfolio. So it’s worth having some Canadian exposure, perhaps with the Canadian market exchange traded fund (ETF) iShare MSCI Canada Index (NYSE: EWC).

For years it was almost fashionable to dismiss Canada from an economic standpoint. Now, however, that may well be where the smart money would like to go. As an economy, Canada is competent and stable.

It’s the kind of country that looks to be a good place for some of our money.

When we were in college we had no money. In the summer we had to work two jobs to try to save enough cash to continue. One summer, we worked in a boatyard in Annapolis early in the morning…then, we did an evening shift painting television towers. Painting the towers was such dangerous work our poor mother begged us to quit. But the money was good – $5.25 an hour – so we had to keep at it. More about that in a minute…

We’ve only got a minute before they call our flight, so we’ll make this short. Nothing much happened in the markets on Friday…except that the price of gold rose $11. Gold seems ready for another attack on the $1,000 level. Will it get there? Maybe…maybe not.

Humility! Humility!

We have to remember that the world economy has never, ever been in a fix like this. We don’t know where it will lead.

The big picture is that the credit cycle – expanding since the end of WWII – seems to be contracting.

“The joy of buying falls victim to recession,” says a headline in today’s International Herald Tribune. The article tells us how people are planting gardens again…saving money…making do.

This is likely to be a fundamental shift, not a transient one. But – humility! – what do we know?

What we suspect is that the upward trends of the last half a century have now reversed. We’re in a period when the excesses and mistakes of the boom/bubble period must be corrected. A new model for the world economy must be found – because China can’t continue to sell products to Americans if Americans can’t continue to buy them.

But there’s more to this big picture. Never before in history have so many government officials been so sure they could stop a correction. And never before have they had more ammunition at their disposal. The numbers are all over the place. And they’re huge. The Obama administration, for example, expects to run $9 trillion in deficits over the next 10 years – and that number is based on a recovery! Imagine what will happen if the economy doesn’t recover?

Here at The Daily Reckoning, we don’t expect a recovery, not now…not never. Because the old model no longer works. Debt got too big…too expensive…too risky. Something had to give.

But what gives now? What happens when a world economy of $50 trillion per year tries to correct and governments try to stop it? What gives when the world’s largest debtor borrows $9 trillion trying to prevent nature from taking her course?

Until tomorrow,

Bill Bonner

Source: A New Model for the World Economy

Achilles was said to be dipped in the river Styx and made invulnerable. But his mother held him by his heel, leaving that part untouched by the magic waters. Naturally, that is where a poison arrow got him.

The moral of this story is that you have to go all the way. If you want your baby to be invulnerable, put him all the way under the water… even the heels. Or, maybe there’s another point: that there’s always some place where you’re vulnerable.

For the purpose of today’s tale, we’ll take the second possibility. Try as you may, you can never escape all risks.

All over the world, consumer prices are falling. The world has too much capacity… too many factories… and too many workers. Too many, that is, for current demand. The ‘world’s mouth’ – the USA – has gone on a diet. And if the US reduces its intake, that means the rest of the world – especially China – must reduce its output. Otherwise, the whole thing will become unbalanced.

Yesterday’s news tells us that despite press reports of a recovery, the key indicators of real economic growth are still falling. Almost one out of 10 mortgages are now delinquent. And the rate of foreclosures is increasing faster than any time in the last 30 years. Housing prices, meanwhile, fell 16% in the 2 nd quarter, from a year earlier, according to the National Association of Realtors.

Unemployment claims went up last week. The sharp eyes of the Financial Times see the link: “Mounting joblessness fuels US housing crisis,” says its headline.

In the real economy, people are cutting back… with the inevitable results we discuss every day here in the Daily Reckoning. One major consequence of reduced demand is too much supply. The factories built in China to supply products to America during the bubble years now find they have no market.

Currently, overcapacity and oversupply are causing prices to fall. Falling prices mean rising currency values. Each unit of ‘money’ buys more stuff. But there are many competing currencies, and they don’t all rise and fall together. Even in a world of deflation, some currencies will deflate more than others.

The dollar is, of course, the world’s main money. In a sense, the whole world economy is under its heel. But it is a heel that has never been dipped in the river Styx. It is now a heel that waits for an arrow.

PIMCO is the biggest manager of bond funds in the world. It says the greenback is going to lose its status and lose its value.

“Investors should consider whether it makes sense to take advantage of any periods of U.S. dollar strength to diversify their currency exposure,” says its Emerging Markets Watch report. “The massive amounts of U.S. dollar liquidity produced in response to the crisis” doom the currency.

Both China and Russia are calling for a new global currency to replace the dollar.

“While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” continues the PIMCO report.

Meanwhile, our old friend Jim Rogers says he is moving all his assets out of dollars and buying Chinese yuan. And Warren Buffett warned this week – writing in the New York Times – that “greenback emissions” threaten the whole world econo-system.

But what does it mean? What are the threats to you? What are the opportunities? If you pay your bills and keep score in dollars, what does it matter if the dollar loses value against the yuan? If prices are generally falling, the dollar is actually getting stronger, isn’t it? So what if some other currencies are getting even stronger still?

The trouble with the Achilles heel is that it is connected to the Achilles tendon… which is connected to the leg muscles… which is what keeps the whole thing moving forward. Cut the tendons and the feet go flippety, floppety and you get nowhere.

Yesterday came word that the US deficit for 2009 might come in lower than expected. Instead of borrowing $1.8 trillion as anticipated, the feds might only borrow $1.58 trillion. Well, that still leaves them about $680 billion short – even if every dollar of trade deficit and every dollar of domestic savings is applied to it. But definitely a step in the right direction! This gap must be closed by quantitative easing, that is to say, by printing press money. So, holders of old dollars are bound to wonder how much their savings will be weakened by the addition of so many new ones.

They’re likely to wonder, too, how much those US Treasury notes will be worth after this monetary inflation catches up to them. At some point, they are likely to think twice about buying more of them… and possibly even want to sell the ones they have already. Either way, it could create a nasty financial whirlpool which sucks down the entire world economy. As private investors reject US dollar credits, the Fed would be forced to print up more money to buy them itself. As the Fed buys more, private investors become more fearful that this monetary inflation will lead to consumer price inflation; they may panic and dump all dollar-denominated assets.

But if investors drop the dollar, what do they take up in its place? Oil… maybe. Oil is selling for $72 a barrel, even while the world is in a major downturn. What makes it so expensive, if not the fear that the currency in which it is quoted is more slippery than the black goo itself? And gold? Yesterday, gold lost $3. But is still trading in the mid-$900s – not far from its all-time high. And this at a time when consumer price inflation is going down! In the US non-oil export prices are falling at a 5% rate. If people are buying gold as a hedge against inflation, they must know something we don’t. Consumer prices are falling…actual CPI rates are negative in many countries already. Take out the effect of speculation on oil and commodities, and deflation is probably a fact of life almost everywhere. Gold buyers are not hedging against an increase in the price of bread, in other words; they’re hedging against a poison arrow directed at the dollar itself.

*** It is a real Ouzilly summer.

We feared we would be alone this summer. Our children almost all grown, we imagined ourselves sitting on the veranda and talking just to each other, like a pair of old shoes left in the closet. No family was coming from the US to visit. Our daughters were pursuing their careers. Our sons had plans of their own.

But then a Swiss friend came. And then his mother came. And then the boys showed up. And then an Irish journalist. And then and Italian egg producer. And then an Argentine singer. And then, a girl from across the street. And then a girl from the village. And then… the house was full…

In the kitchen yesterday, three women busied themselves… making jam… polishing the old stove… sharing gossip and jokes. It was like a scene from an earlier era… when people had regular kitchen staff. Our ‘staff’ are all volunteers and part-timers. Still, the ambiance was rich and convivial.

“Do you want a cup of coffee?” one asked.

“Yes… but I’ll make it….”

“No… I’ll make it… you shouldn’t make it. You’re the head of the house. You’re the one who keeps the place going…”

“Oh… yes… well… that’s a nice way to look at it…”

“Yes, without you, we’d have to go to the beach for the summer… and we wouldn’t have the pleasure of working in this hot kitchen. I’m just joking. It’s fun working in the kitchen. This is where the action is. Did you know that? It was always the kitchen that was the place to be… in these big old houses. That was where the maids and gardeners and all the staff hung out… in front of the fire. It was often the only warm room in the house. Everyone wanted to be in the kitchen. And it was where the food was.

“And people in the kitchen know what is going on… The maids come down and report on the state of the bedrooms… and who is sleeping with whom. Yes… that’s the way it was… at least in France. And they hear who is arguing with whom… and about what. And the staff keep their eyes and ears open… and then they come into the kitchen and talk. There were never any secrets in a place like this… the people in the kitchen knew everything…”

Source: The Achilles Heel of the World Economy

Here is Warren Buffett’s view:

“Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need.

“They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue.

“The United States economy is now out of the emergency room and appears to be on a slow path to recovery.”

This is probably the view shared by most economists and most investors. It is not our view. From where we sit there is no recovery underway…and there never will be one. You can recover from a hangover. You can recover from a nasty divorce. You can even recover from an earthquake. But once a depression begins, you can only endure it. Get on with it. Get it over. And then, you can begin rebuilding again. You will never recover the economy you had before the crisis. You must find a new economic model.

A headline from yesterday: “Reluctant shoppers hold back recovery.”

That’s one way to put it. Shoppers don’t have any money. They need to cut back. Most likely, they will cut back until their savings rates reach 10% of disposable income. That will take $1 trillion out of consumer spending. The economy cannot possibly recover under those conditions; it can’t return to its same old, consumer-led, credit-fuelled self. Instead, it must go through a period of transition – in which output is depressed – until it finds a new personality, better suited to the new economic circumstances.

But Buffett is not worried about the depression. He’s worried about how the recovery is financed:

“.. enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.”

Buffett does the maths. This year, the US deficit will total $1.8 trillion. Since 1920, the largest peacetime deficit was 6% of GDP. This is 13% of GDP. The magnitude of it alone should be cause for alarm. But there’s more. Where does this money come from? Even if you could direct 100% of the net US trade deficit (about $400 billion, the money that ends up in foreigners’ hands as a result of American spending) and 100% of American’s savings (estimated to be about $500 billion), you’d still be $900 billion short.

Desperate borrowers should expect to pay high rates of interest. A borrower who doesn’t need the money can shop for the best rates and hold out for a good deal. But when a person needs to borrow, he takes what the market gives him.

Yet, one of the most curious things about the financial world circa 2009 is the yield on the 10-year Treasury note. It has fallen to under 3.5%. Despite record borrowing by the feds, lenders content themselves with the lowest yields in nearly half a century. Go figure.

The market seems to be anticipating a depression. Why else would bond yields be so low? If the economy sours…and the stock market sinks…the safe yields on Treasury bonds will seem like a good alternative. But Buffett believes the Treasury yields are not as safe as they appear. That other $900 billion has to come from somewhere. And the feds can’t allow interest rates to rise significantly; that would undermine all their stimulus efforts. High real interest rates depress economic activity. So, what can the feds do?

“ Washington’s printing presses will need to work overtime,” says Buffett prophetically.

Of the two ways of financing the deficit, one is a flimflam; the other is robbery. In the great credit expansion consumers borrowed so they could buy things such as automobiles. Now, the feds borrow and bribe the voters with money to buy automobiles. No matter who does it, borrowing for consumption is merely taking from the future. Then, when the future comes…the account has to be settled. Result: no net gain. What was consumed in one year is not consumed in the next.

Of course, the feds don’t spend money the same way consumers did. Consumers wasted their money on frou-frou and watchamacallits of their own choosing. The government wastes money on different things – like turtle crossings and billion-dollar bailouts.

Not that we’re complaining about government spending. We’re just pointing out that it’s not the same as private spending. What makes goods good is that people choose them and buy them with their own money. They get what they’ve got coming. But the feds are spending other peoples’ money. If they get any goods at all it is practically an accident.

But what we’re talking about this morning is the dollar. According to Buffett, the dollar is in danger. He’s worried about the larceny, not the flim-flam. Printing up additional dollars robs savers. Each new dollar created to buy US debt makes each one already in existence – say, in a vault in the Bank of China – worth less than it was before. If that isn’t true, the whole body of economic thinking from Adam Smith to Irving Fisher is nothing but a fantasy. And the only way to protect the value of the dollars held by savers, theoretically, is to withdraw the stimulus money before inflation sends prices soaring.

Buffett is an optimistic fellow. He believes that responsible authorities will turn off their dollar-printing machines in order to protect the greenback. Here at the Daily Reckoning, we’re not so sure.

First, the depression is likely to be worse than people think. This will mask the effects of dollar printing. Plus, it will make the need for more dollars – more federal spending, more US debt – seem more urgent than ever. Instead of pulling the plug, they’ll turn up the speed.

Second, the feds are not really interested in the health of the real economy anyway. This is an insight which is obvious, but one that only came to us recently. When the feds put in place absurd policies to delay and restrain the inevitable correction, they are making things worse, generally, for everyone. But the politicians are responding to their constituents’ demands. One campaign donor wants to keep his business alive. Another wants to keep his job. Still another promises the feds high paying jobs on Wall Street, after their term in Washington is over. Millions of others — more than enough to turn an election – want free pills and mortgage subsidies and so forth. When the feds try to bailout the economy, they are only doing their jobs! They’re not going to stop doing their jobs – especially in a depression – just to protect foreign dollar-holders.

Source: Flim-Flam, Robbery and the Economics of Depression

In fact, when you peruse the news it’s difficult to come to any other conclusion. For instance:

• A number of key earnings reports have been much better than expected, and company executives buttressed those profit figures with positive comments about the next 18 months.
• The trading operations of Goldman Sachs Group Inc. (NYSE:GS) and JPMorgan Chase & Co. (NYSE: JPM) both just reported record profits.
• U.S. housing prices rose in May for the first time in three years. Initial jobless claims have plunged 15% since their April peak. The Conference Board’s Index of Leading Economic Indicators rose 0.7% in June, its third successive positive reading.
• And just yesterday (Thursday), the Dow Jones Industrial Average topped the 9,200 mark for the first time since November – a potentially highly bullish development for the economy, since stock prices are forward-looking.

But while many experts will look at these developments as an excuse to celebrate the looming rebound to come, I actually see them as a real cause for concern. The reality is that these reports, when viewed in concert with other data, are actually a sign of a re-inflating financial bubble.

This is actually an “Economic Recovery Trap” that – when sprung – will inflict a lot of pain on overly optimistic investors. Now that we’re sufficiently forewarned, we should re-orient our money accordingly.

Doomed by Deficits

It’s not surprising that the U.S. economy has shown signs of strength in recent weeks; it has had huge amounts of money thrown at it.

On the fiscal side, the Obama administration’s May budget plan suggested deficit for the 2009 fiscal year (which ends in September) would reach $1.83 trillion – about 13% of gross domestic product (GDP).

However, subsequently released unemployment figures have shown that the U.S. jobless level reached 9.5% in June, far above the 8.3% rate assumed in the budget. And unemployment is expected to spike further in the second half of the year.

This worsening unemployment situation strongly suggests that the true budget-deficit figures will be even worse than those already announced, a supposition strengthened by the postponement – from mid-July to mid-August – of the normal mid-term budget review. Since U.S. President Barack Obama is currently attempting to steer two difficult and expensive pieces of legislation – the cap-and-trade energy bill and the healthcare-reform bill – through Congress, he does not want unfavorable budget numbers appearing that might be used to persuade wavering legislators to oppose them.

Even at 13% of GDP in fiscal 2009 and 10% of GDP in fiscal 2010, the U.S. federal deficit is far above any previous level reached in peacetime, so it’s likely that if the economy begins to recover these deficits will prove difficult to finance, meaning the budgetary shortfalls will push up long-term interest rates.

That escalation in long-term rates, in turn, could choke off the economic recovery, which to be healthy requires a rebuilding of inventories, extensions of credit to new domestic-and-foreign customers, and a revival of enthusiasm for such large-ticket items as housing and automobiles.

With the yield on 10-year U.S. Treasuries already up from a low of 2.07% in December to a recent level of 3.60%, the dampening effect of rising interest rates may already be becoming apparent. In any case, the deficit is a dark cloud that threatens to obscure the economic outlook.

And that dark deficit cloud will be very difficult to remove.

Know Your (Real) Enemy

The other main problem with today’s economy is the likely resurgence of inflation. Even the U.S. Federal Reserve – which under central bank Chairman Ben S. Bernanke for a long time apparently maintained a fear of deflation above all else – admitted in its last meeting that the likelihood of deflation had receded.

That’s not surprising: In the last six months, core consumer price inflation (excluding food and energy) was a reported 2.4% annually. Although the “headline figure” has been low because of the sharp drop in energy prices the United States economy has experienced since last year, that effect is about to disappear, as energy prices peaked in early July 2008 and fell sharply throughout the fall. Thus, even reported consumer price inflation – on a year-over-year basis – is likely to surge in the months after this one (July).

Moreover, the reported inflation figure may be low. Each month, the U.S. Bureau of Labor Statistics “seasonally adjusts” consumer price statistics to remove normal seasonal patterns from the data. That seasonal adjustment process is thoroughly opaque, and is subject to manipulation. In the early months of 2008, for example, when reported inflation was high, the downward seasonal adjustments were consistently much larger than the average of the decade 1998-2007. The process was then reversed late in the year, when reported inflation was negative, but the upward seasonal adjustments made it less negative. For the year as a whole, “seasonally adjusted” inflation was 0.5% below unadjusted inflation, which shouldn’t happen, except by bizarre rounding effects.

In the first six months of 2009, the negative seasonal adjustments have re-appeared, to the extent that total seasonal adjustments for the six months were minus 1.2%, compared with a 1998-2007 average of minus 0.61%. If the seasonal adjustments are indeed wrong, and should have been at only the average level, then “core” price inflation in the six months to June would have been 3.6% annually.

Not only is that not deflation; it suggests accelerating inflation.

Money Supply Moves

Another reason I wouldn’t be surprised by a reappearance of rapid inflation is the big increases in the money supply we’ve seen over the last year.

According to St. Louis Fed data, the M2 money supply has increased by 8.8% in the last year. The St. Louis Fed’s own Money of Zero Maturity (MZM) – the best measure of the broad U.S. money supply available since the central bank ceased reporting M3 in 2006 – jumped 10.2%. And the overall monetary base zoomed an astounding 92.8%.

In addition, the Federal Reserve has bought $300 billion of government bonds, always an inflationary warning signal since it monetizes the deficit. Furthermore, the Fed and the government together have engaged in rescue, stimulus and guarantee programs totaling an astounding $23.7 trillion, according to Neil Barofsky, inspector general for the government’s Troubled Assets Relief Program (TARP). A “gross” number if ever there was one, that figure is nearly twice overall U.S. GDP.

Let’s face reality: We’re going to be paying this bill for decades to come – almost certainly largely through resurgent inflation. In those circumstances, the recovery in the stock market is based not on reality, but simply on a bubble – an assertion that’s already been vindicated by the extraordinary afore-mentioned profitability of the Goldman Sachs and JPMorgan Chase trading operations, which typically benefit enormously when bubbles are inflating and there is too much money sloshing about.

The near-bankruptcy of CIT Group Inc. (NYSE: CIT), and the losses recorded by the commercial banking sides of Citigroup Inc. (NYSE: C) and Bank of America Corp. (NYSE: BAC), demonstrate that even in a period when short-term rates are exceptionally low, conventional commercial banking is not currently a moneymaker.

Other then Goldman Sachs shares (whose prosperity is likely to be short-lived), it is clear that our investment dollars should be concentrated in two areas:

• Conservatively run overseas economies.
• And inflationary hedges such as gold and silver.

Let’s look at some investment opportunities in each category.

First, we should buy moderately priced shares in countries where “stimulus” has been limited and in which monetary and fiscal policies are close to balance. The two largest such countries are Germany and Brazil, so you should look at the Germany ETF iShares MSCI Germany Index (NYSE: EWG) and the Brazilian iShares MSCI Brazil Index (NYSE: EWZ).

Second, you should make sure that a substantial portion of your assets are in inflation hedges such as gold and silver, either in the metals directly through SPDR Gold Shares (NYSE: GLD) and iShares Silver Trust (NYSE: SLV) or through gold mining shares, the exchange-traded fund (ETF) for which is the Market Vectors Gold Miners ETF (NYSE: GDX).

Source: Beware of the Obama Stimulus Trap

Summer begins in 3 days. We can hardly wait. We predict it will be a killer.

Several interesting things are likely to happen this summer.

1) Unemployment rates will go up.

2) Rising joblessness will increase rates of defaults, foreclosures, and bankruptcies. Not just at the consumer level – but throughout the system… including banks, states, businesses, as well as households.

3) The stock market will take a dive as earnings fall and investors realize that there will be no quick recovery.

Oh… and one more thing: US bonds could collapse. But watch out; here’s where it gets tricky. Another swoon in the stock market could send investors running for the smelling salts in the bond market. A collapse of bond prices, on the other hand, could send them helter-skelter into stocks.

Yesterday, the Dow rose 7 points. Oil held at $71. The dollar lost a little ground – to $1.39 per euro. And gold added 3 bucks.

It is impossible to predict what will happen – or when – in the markets. So let us turn our attention to the real economy. Here, we see the picture more clearly: We’re in a depression. We write depression with a small ‘d.’ We’re saving the big one for later.

Few economists or analysts will tell you we’re in a depression. They’re looking at “green shoots” and rising trendlines. They’d do better to read a little history. Such as the history of the Great Depression.

Martin Wolf in the Financial Times (reporting the results of a study by two American professors):

“First, global industrial output tracks the decline in industrial output during the Great Depression horrifyingly closely. Within Europe, the decline in the industrial output of France and Italy has been worse than at this point in the 1930s, while that of the UK and Germany is much the same. The declines in the US and Canada are also close to those in the 1930s. But Japan’s industrial collapse has been far worse than in the 1930s, despite a very recent recovery.

“Second, the collapse in the volume of world trade has been far worse than during the first year of the Great Depression. Indeed, the decline in world trade in the first year is equal to that in the first two years of the Great Depression. This is not because of protection, but because of collapsing demand for manufactures.

“Third, despite the recent bounce, the decline in world stock markets is far bigger than in the corresponding period of the Great Depression.

“The two authors sum up starkly: “Globally we are tracking or doing even worse than the Great Depression … This is a Depression-sized event.”

Yesterday, we proposed two sine qua non for a new boom. Either the feds revive the old economy – by getting people to borrow and spend more money. Or, the mistakes of the past must be corrected… whereupon new investment and growth can take place. While the free market is busy working on the latter, central banks and national governments all over the world are trying to stop it. They’ve got the voters and campaign contributors to answer to, none of whom wants to get what he deserves. Instead, they’re hoping to revive the Bubble Epoque. Citizens are already up to their necks in debt; but the feds raise the water level!

This flood of fed liquidity seems to be raising boats and animal spirits among speculators. But it is doing nothing to revive the real economy.

“Consumer Costs Fall Most in Six Decades,” reports Bloomberg. Europe is already in deflation. America is not far behind. We had a hard time following the Bloomberg report. It said consumer prices were 1.3% below those of 12 months ago. We don’t believe that’s true. What we think Bloomberg meant to say was that prices are increasing at the slowest pace in 6 decades… but, for the moment, inflation is still (barely) positive.

With prices falling, the last thing the feds are worrying about is inflation. Except that there isn’t any. And they’re going to worry a lot more over the summer, when the hot sun beats down on a lifeless economy and it becomes obvious that their revival efforts have failed.

Meanwhile, Theo Casey’s predicting it the other way. He’s predicting an “H-Bomb” ahead… “H” for hyper-inflation.

And more thoughts for the summer ahead:

*** Global commerce has fallen in line with the Great Depression. That means producers don’t need to produce so much… and don’t need so many people to produce it. Jobs are lost. And then the people who lose their jobs don’t go out to restaurants and malls so much… so more jobs are lost.

These job losses take time to show up. And then they take time to “ripen.” People tend to have a little something set aside for a rainy day – or at least, unemployment compensation. But after a few weeks of stormy weather, the reserves are exhausted. Then… they have to cut back much more.

USA Today asked people: “If you lost your job, how long could you afford to pay for your own health insurance?” More than 65% of respondents said they could only manage for 6 months or less.

In America “there hasn’t been a shock like this since the de-mobilization of millions of soldiers following WWII: something like 3 million unemployed people are going to fall out of the safety net in the third quarter. With their families, that’s about 10 million people who will sink suddenly into deep poverty,” says GEAB a private research service headquartered in Paris. The group anticipates a “Very Great Depression” coming to the US.

More than three million jobs have been lost in the US during the last 5 months. As these out-of-work cases ripen, there will be some rotten fruit falling to ground.

There are also the millions who are working fewer hours and earning less money. In fact, the number of hours worked per week has fallen to a record low.

Where do people without jobs, without incomes, without savings – and without benefits – shop? What money do they spend? How does a consumer economy launch a boom when consumers have less money to spend?

These questions have obvious answers and obvious implications: there ain’t going to be any consumer spending boom in the USA… not this summer… and probably not for many summers to come. Martin Wolf explains why:

“Robust private sector demand will return only once the balance sheets of over-indebted households, overborrowed businesses and undercapitalised financial sectors are repaired or when countries with high savings rates consume or invest more. None of this is likely to be quick. Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade. Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. Deleveraging is a lengthy process.” .

If we assume that debt levels need to go back to where they were before the Bubble Epoque… well, let’s say to 200% of GDP just to make the maths easy… that means 170% of GDP worth of debt needs to be paid off. That’s $20 trillion, in round numbers – or about 40% of the total. At 6% per year, even if households kept paying off debt at the current rate it would still take nearly 7 years to get household debt down to pre-bubble levels.

Then, of course, there is the government debt – now expanding faster than ever. The US has the biggest deficit – even as a percentage of GDP – of any serious country in the world. The US deficit is 12% or 13% of GDP. Compare that to Russia at 2.6%…. Spain at 6%… France at 5%… Brazil at 1.3%…. Even Argentina has a much smaller deficit than the US – only 3.6% of GDP.

(More on the pampas tomorrow….)

But don’t worry about it. The ‘Committee to Save the World, Part II’ is on the case. Geithner, Bernanke and Summers are staying in the office throughout the hot months. They kept us out of trouble so far, didn’t they?

So enjoy the beach!

*** The US has entered the Third Stage of a great nation. The Political Stage.

In the late 20th century, power and money moved from the banks of the Monongahela to the banks of the Hudson. Now they’re moving again – to the banks of the Potomac. Washington calls the shots.

“Obama Blueprints Deepen Federal Role in Markets,” says a headline in yesterday’s Washington Post.

Of course, this change didn’t happen overnight. George W. Bush was a trailblazer – turning ‘conservatives!’ into big spending activists. And the business community – particularly the banks – saw it coming and got ready.

In 2001 the banking industry spent $5 million on lobbying in Washington. The total went up every year. By 2008, they were spending $20 million. Campaign contributions from bankers increased too… from only $4 million from the bankers’ political action committees in 2000 to $8 million last year.

Judging from the bailouts given to Wall Street last year, this investment paid off handsomely.

Source: Killer Summer Ahead

Good day… And a Thunderin’ Thursday to you! It’s a Thunderin’ and lightenin’ here in St. Louis. It all began last night, went through the night, and still hangin’ round this mornin’! Yes, I’m into dropping “g’s” today! HA!

Well… We had “Turn Around Tuesday”, and that was fallowed by “Whipsawed Wednesday”! The euphoria of the dollar bears, turned quickly yesterday, with the dollar bouncing back… I’ll tell you this dollar has more lives than a cat! But that’s OK… I certainly don’t want to see a dollar collapse, as some have called for… I just want to see it at a “fair” level, given the fundamentals of exploding deficit spending… That seems fair, eh? Trends… Weak dollar, strong dollar, alternating throughout time… Well, at least since Nixon closed the Gold window in August of 1971!

There was plenty to sell dollars on yesterday, but the dollar bulls got some wind in their sails in the afternoon, after the Fed Beige Book was printed… Now, I know, I said yesterday that the Fed’s Beige Book rarely moves a market… But that’s what seemed to happen yesterday… The Fed’s Beige Book reported that all the districts saw that economic conditions remained weak or worsened through May. This news threw cold water over the “the recovery is on its way campers” and pushed Risk Aversion to the front of the class once again.

Overnight though… This news was erased when “upon further review” it was reported that five of the Fed districts saw the downward trend in activity showing some signs of moderation. So… Just like I said a couple of weeks ago… This daily back and forth reminds me of a Wayne and Garth street hockey game… Yesterday it was “game off!” today, it’s “game on!”

The really big news that caught everyone attention yesterday was reported by all the major media outlets, and the title of the story was… “Russia to sell U.S. Treasuries, to buy IMF Bonds”… Now, that title alone should have sent a shot across the dollar bulls’ bow… But, I guess the dollar bulls weren’t paying attention… They were probably still rejoicing the Jobs Jamboree farce from last Friday! HA!

Seriously though… Of Russia’s over $400 Billion in reserves, which are held in Treasuries, they plan to allocated $10 Billion to the IMF bond program… So… In reality the Title is a bit misleading, eh? I mean they could have said, “Russia to diversify $10 Billion of Treasuries to IMF Bonds”… So, this doesn’t sound like a Chicken Little story right? Well, not so fast there Tim!

Didn’t China announce last week that they were going to buy as much as $50 Billion of the IMF Bonds? $10 Billion here, $50 Billion there, and pretty soon we’re talking about a large sum of Treasuries getting sold!

And with that in mind, the 10-year Treasury hit 4%! Later in the afternoon, we saw this 4% yield, which was 3.87% at the start of the day, come back to 3.93%… Hmmm… You don’t think that the Fed bought Treasuries do you? I mean, they have carte blanche to do this whenever they feel it to be necessary! And with yields going to 4%, I guess it was necessary!

And, the assumption that the Fed used Quantitative Easing left the dollar hanging out on a line overnight, and Asian traders first, then European Traders pushed the dollar down… Now… I’m watching the currency movements since I came in, and it’s more of the back-n-forth stuff we’ve seen for a couple of weeks now… (the euro was 1.4005 when I came in, traded to 1.4030, and now back to 1.4005) But, the important thing to notice is, while the dollar makes its comebacks / rebounds, at the end of each week, the dollar is lower overall… This makes for a trend people…

Whenever the Risk Aversion campers take their ball and go home, the high yielders / Commodity Currencies get the court, and they start slam dunking the ball! In other words… They kick some dollar tail and ask names later! The high yielders / Commodity Currencies of Australia, New Zealand, Brazil, South Africa all see huge chunks of investments coming their way when “risk” is back on the table. The Canadian dollar / loonie, is a Commodity Currency, but surely (Hey! Who’s Shirley?) not a high yielder! But with Oil prices now touching $72, the loonie is once again on the rally tracks!

Overnight, the Reserve Bank of New Zealand (RBNZ), left rates unchanged and didn’t jawbone about keeping the rate cut door open… RBNZ Gov. Alan Bollard said: “The economic outlook remains weak both in New Zealand and in other countries. However, there are signs that international economic activity is stabilizing, and international financial conditions are improving. We expect the New Zealand economy to begin growing again toward the end of this year but the recovery is likely to be slow and fragile.”

Sounds like Bollard has taken on my friend John Mauldin’s line about a “muddle through” economy!

While we’re “down under”… Australia saw employment data last night, and it paved the way for a strong performance overnight for the A$… Job losses were negligible in May, falling just -1.7K, when a negative -30K was expected. The thing I think that’s very interesting here is that the Aussie futures are pointing to rate hikes early next year… Of course that’s all based on the rosy outlook the markets seem to have right now…

Now… For Australia that might be all fine and dandy, as their fortunes are tied to China, not the U.S. But here in the U.S. the rosy outlook the markets have right now is to me, like putting the cart before the horse, as we might want to see a “bottom” before we recover!

Well… The Trade Deficit in the U.S. was as expected widening from a revised upward $28.5 Billion in March to $29.2 Billion in April… The number that was even more concerning was the Budget Deficit of $189.7 Billion… This puts us on target for $2.3 Trillion in a Budget Deficit, and then you have to add in the $787 Billion Stimulus, that’s not accounted for in these numbers… That puts us over what I said we would be this year… Over $3 Trillion Budget Deficit…

Now… How many more Treasuries are going to have to be auctioned off to cover that nut? Can you say… Treasury Bubble, popped? I knew you could! The foreigners we need to buy these Treasuries are going to demand a higher yield… And… I don’t think the Fed has enough money to keep buying Treasuries in an attempt to keep yields lower, no wait! Just like Helicopter Ben, told us before he was Fed Chairman… “The U.S. Government has a technology, called a printing press.” They can print what they don’t have!

Any way… What I’m getting at here is that yields will rise, but not to the degree the foreigners want to see… So… The clearing mechanism for these Treasury purchases, gets discounted… And class… What’s the clearing mechanism that will be discounted? (play the Final Jeopardy music) the dollar! I knew you had it all the time! The dollar will be allowed to be debased even further to allow the Treasuries to be bought at a discount.

Oh, there will be the usual shallow statements that “the U.S. believes in a strong dollar”, but then those that say that will have their fingers crossed behind their backs!

OK… The data cupboard has a Biggie today in Retail Sales… The Weekly Initial Jobless Claims will also print as usual on a Thursday. May’s Retail Sales are expected to rebound from April’s poor showing of -.4%… The BHI (Butler Household Index) also agrees that May will rebound. I think if this report does rebound, the “it’s all clear” campers will come out in force… And… That may cause the dollar to lose more ground, as those that purchased dollars and dollar assets as safe haven trades, will no longer see the need to own their safe haven trade!

And then in the “I still can’t believe we’ve come to this” category… The Treasury Department on Wednesday appointed a well-known Washington lawyer, Kenneth R. Feinberg, to oversee the compensation of employees at the seven companies — the American International Group (NYSE:AIG), Citigroup (NYSE:C), Bank of America (NYSE:BAC), General Motors, Chrysler and the financing arms of the two automakers.

He will have broad discretion to set the salaries and bonuses for their five most senior executives and their 20 most highly paid employees.

I know, I know, I shouldn’t swim in these waters, but you know me, I can’t help but get myself into these things… But… This is just the beginning folks… I told you months ago that this was going to happen when the Gov’t began to bail out Financial Institutions. They’ve got their hooks in this fish now, and have you ever seen the Gov’t give back something they had gained? It will only get worse… And worse… And worse…

And it will all be OK because these are “extraordinary times, which call for extraordinary measures” right? HOGWASH! This is really baaaaaaaaaaaaaaddddddddddd folks…

OK, on that note! Let’s go to the Big Finish!

Currencies today 6/11/09: A$ .8130, kiwi .6425, C$ .9065, euro 1.4005, sterling 1.6455, Swiss .9255, rand 8.05, krone 6.3475, SEK 7.6750, forint 200, zloty 3.20, koruna 19.12, yen 98, sing 1.4520, HKD 7.7510, INR 47.59, China 6.8368, pesos 13.62, BRL 1.9470, dollar index 80.09, Oil $72.10, 10-year 3.93%, Silver $15.09, and Gold… $950.50

Chuck Butler

Source: Whipsawed Wednesday!

“You ain’t seen nothin’ yet!”

Actually, we’ve seen so much already that it’s hard to believe there’s more coming. But there’s sure to be more… and we have a feeling it will be worth the wait.

Yesterday, for example, GM filed for Chapter 11 bankruptcy protection. It couldn’t pay its bills. GM was once the strongest corporation on the planet. But it has been around for nearly 100 years. Heck, everything wears out eventually… even a ’55 Chevy.

“Obama Nationalizes GM,” says a triumphant headline in France’s “La Tribune.”

Triumphant?

Yes. According to the papers, Obama may have been handed the keys to GM… but the old jalopy is worn out. The French say the whole US economic model is ready for the junkyard. More on the French – and the French model, below…

First, let’s stick with the USA. The Dow rose 221 points yesterday – to 8,821. Investors think the worst is over.

Everything is going up. Copper is up 65% so far this year. Oil is up 53%. Soybeans are up 22%. Stock markets are up about 30% worldwide. And gold is up 12%. In this company, gold is a laggard!

Copper has risen so much, say the papers, because China is buying all it can get. What it is doing with the stuff we don’t know; maybe it is stocking up at what it believes are low prices.

Maybe it is hedging its bets. China has the biggest pile of Treasury bonds in the world – $768 billion of them. That’s 768 billion reasons to worry. That’s because each T-bond is denominated in dollars… and while everything else is going up, the dollars is going down. Yesterday, the dollar touched a new low against the euro for this year – at $1.42.

T-bonds are down too – minus 5% for the year. It would not be at all surprising for the Chinese to be stockpiling oil, gold, copper and all the other inflation hedges they can get. Their dollar-denominated bonds may go down… but their commodities and gold would go up. Overall, they’d come out even.

This week, Mr. Tim Geithner – the big banks’ main man in Washington – is in China trying to reassure the Chinese that America takes its financial obligations seriously. That’s something we never expected to see either. America may have the strongest economy on earth. But if the commies stop financing it, we’re out of business.

So Geithner is in China, hat in hand, like a major debtor called into the banker president’s office. Geithner, of course, has no choice. He has to go and say what he has to say. He will use all the right words. He will show the appropriate seriousness… he will smile when it is called for… and put on a grave face when he needs to.

The trouble is, there’s little he can do to help the Chinese. They want him to protect the dollar and the bond market. That’s something he can’t do.

“It will be helpful if Mr. Geithner can show us some arithmetic,” said Yu Yongding, a former advisor to the Chinese central bank.

Yes, we’d like to see that arithmetic too. How do you add $1.75 trillion in deficits, pay for it with funny money from the Fed… and still come out even on the value of the dollar? There’s no arithmetic we know of that works in the Chinese favour.

Right now, the numbers and the logic of the situation are telling us that feds aim to create inflation. Instead of trying to keep prices under control… they’re trying to get them to go up. That’s yet another thing we didn’t expect to see!

The US government is less concerned with protecting foreign lenders than it is with getting the US economy back to its old E-Z money ways. Cheap money is what people want. Cheap money is what the feds are trying to give them.

Today – will wonders never cease! – the US is pushing its phony money all over the world. The Chinese, meanwhile, are champions of financial integrity. Just wait until they give up on US bonds… then, we’ll really seen something we ain’t seen yet!

And more thoughts…

*** The French think they were right about everything. Iraq, for example. The French have deep ties to the Arab world. They knew Iraq would be a tar baby for the US – just like Algeria had been for them. You pick it up… you can’t put it down.

But Congress and the administration not only ignored the French (as they had when Charles DeGaulle advised against intervention in Vietnam in the early ‘60s calling it a “rotten country”) they accused France of cowardice, dumped good bottles of Bordeaux down the drain and renamed French fries ‘freedom fries.’

Remember the jokes? When a bomb blew up a Spanish train, France raised its colour-coded Terror Alert system… from mauve for “Collaborate” to chartreuse for “Run and Hide.”

And remember what Anglo-Saxon economists said about the French economy? It was ‘sclerotic’… it was a ‘museum’… first, it was tied up by labor unions and then the socialist politicians did kinky things to it.

But every dog has his day, and now the French are enjoying a delicious moment of schadenfreude.

The frogs stayed out of Iraq… avoided a housing bubble… and side-stepped a credit crisis.

And now, the “French model” for managing an economy is the envy of the world. At least, that’s what you might think if you read ‘The Economist.’ A recent issue has Sarkozy on the cover… looking confident and pleased with himself. By contrast, Britain’s Gordon Brown and Germany’s Angela Merkel look as though they needed a drink.

What’s the ‘French model?’ It’s a system where the state meddles heavily in the economy. Health care, education and public transport are all government enterprises. And political cronies, rather than entrepreneurs, run key businesses. Heck the French don’t even have a word for “entrepreneur” as George W. Bush pointed out.

It seems to work fairly well. The health care system functions fairly well – while taking a smaller percentage of GDP than in the US. The trains run on time (except when there is a strike). Grammar and secondary schools are probably better than in the US; the universities are probably worse. And many of France’s private businesses are world leaders – Air Liquide, Danone, LVMH, to name just a few that come to mind.

And so far, France has suffered less from the worldwide financial meltdown than any of its rivals. The last time we were in Paris, the restaurants seemed as full as ever; taxi cabs were as hard to get as ever; and Paris property had barely come down at all – at least, officially.

“I’m not so sure… ” said a colleague in Paris. “I’ve been looking for an apartment for the last year. A year ago, there was almost nothing available in my price range. Now, I’m seeing lots of places. I looked at one last week. It is listed at $340,000 – about what it would have been a year ago. But the agent told me that the seller would probably take $275,000. If they’re telling me that right off-the-bat, I figure it might go for $250,000”.

Source: The US is Pushing its Phony Money All Over the World

Poor Obama. He seems like such a likable fellow. He would probably make a good college president. Or a good butcher. You’d enjoy going into his shop to buy cutlets.

But now the poor man finds himself in what has to be one of the tightest spots in history. At least in economic history. The crash of ’08-’09 clipped stock market investors for half their nominal wealth. The bear market in property has put one out of every four homeowners underwater. And now the recession/depression threatens to knock the stuffing out of the rest of the economy.

How can he get us out of this jam? He hasn’t a clue. So, he turns to his advisors… his hacks… his pollsters and his hangers-on…

…and what do they come up with?

“U.S. deficit four times last year’s record,” comes the press report. “Federal government will borrow almost 50 cents of every dollar it spends this year.”

This news would have taken our breath away. If we had any breath left. But after so many wonders, each one more breathtaking than the last, our lungs are all squeezed out. We can’t even give an audible sigh. Hold a mirror up to our nose and you would think we were dead.

You’ll recall that President Obama announced that he had found budget savings of $17 billion. We were exhaling on that for a moment until we realized that it represented less than 36 hours’ worth of federal spending. Then came news a week later that instead of cutting the budget, the latest estimates showed it going up by some $89 billion.

Let’s face it, at this point $89 billion is chicken feed. Here at The Daily Reckoning we carry that much in our wallet. We pass it out to subway bums and use it to tip cab drivers. So, we’re not about to get excited about such a trivial amount.

But coming on top of a budget deficit already estimated at four times the record deficit set last year…and we begin to think of straws and camels.

The idea of spending twice as much as you earn should take even a camel’s breath away. An ordinary man…hearing that fact…would feel like breaking the glass and pulling the alarm. “You can’t do that…you’ll go broke,” he would say. Basic arithmetic reveals the trap. In one year, you’ve built up debt equal to all of next year’s revenue. In two years, you’ve got debt of 200% of annual revenues. In 10 years, you’ve got debts equal to 1,000% of your annual receipts. Let’s see…say you only pay 5% interest…then, the interest alone takes up HALF your revenues. What creditor would lend you money?

The feds have their own projections, of course. According to them, they won’t continue this hell-for-leather spending much longer. Their estimates show the deficits declining in future years. Ten years out, they show a fairly modest total of $7.1 trillion in accumulated deficits.

It is a measure of how breathtaking the financial news has been that $7.1 trillion can in any way be regarded as modest. It is half America’s total GDP. It is also a measure of how out-to-lunch the federal estimators are. Their projections imagine a “worst of worlds” that would be a “best of worlds” to most people. In the Great Depression, national output went down by some 30%…and continued for a decade (depending on how you figure it). In Japan, the on-again, off-again slump has gone on for 19 years. Yet, the official guess is that this downturn in the US will take output down by only 1.2% and that it will be over in a few months…with a return to growth of 3.2% in 2010.

No one knows how bad it will become. The last report showed GDP declining at a 6% rate. And our friend Nassim Nicholas Taleb says it will be “vastly worse” than the ‘30s.

But give a man enough education and he’s ready to believe anything. He can even convince himself that such reckless spending is a “stimulus” effort…that it merely “replaces” spending that would have been done by the private sector (if the private sector were stark raving mad)…and that it will bring about a “recovery” in the entire economy.

You could even glance at the latest financial news and say: “Look…it’s working!”

The Dow lost 155 points yesterday. A minor setback in what has been an agreeable interlude. Oil, the dollar, and gold stayed about where they were yesterday.

Our thoughts return to Mr. Obama. He is surely the man of the hour. He is the fellow historians will take for the leading man. Will he be a tragic hero? A comic hero? One of America’s greatest presidents? A black Lincoln? A Roosevelt with two good legs?

Like Lincoln and Roosevelt, he is a man with no apparent convictions that will stand in his way. Perhaps he is just the man the U.S. of A. needs – a man capable of bankrupting the nation with a smile.

Yes, Dear Reader, the ‘great man’ always seems to come along when you need him. Longtime Daily Reckoning readers will recall our theory:

After the Berlin Wall came down… America had no enemies worthy of the name. She had a monopoly franchise on the world’s money – the dollar was the undisputed queen of the planet’s reserves. And she had a monopoly on military power too – the undisputed king of the hill, with a Pentagon budget nearly as large as all other nations’ military spending put together.

But nature abhors a vacuum and detests a monopoly. Lacking a suitable challenger, America had to become her own worst enemy. Lacking a rival who could destroy her, she had to destroy herself.

And so, when Americans went to the polls in November of 2000, they elected a president who was up to the job: George W. Bush. Eight years later, the Clinton surpluses had turned into the biggest deficits ever…an immense bubble had impoverished the middle class…and the country was engaged in two unwinnable, unnecessary, and hugely expensive wars.

Mission accomplished!

But it’s not over. The millstones of history may grind slowly…but they grind exceedingly fine… The American empire is clearly overstretched and over-indebted. If it is to save itself, it should scale back immediately…cutting the Pentagon budget in half, for example, and eliminating all unnecessary expenses (which is most of them). Instead of spending $3 trillion, it should spend…say…$1 trillion, and run a surplus.

What about the depression, you might be wondering. Isn’t this the time to increase government spending, rather than decrease it? Ah…if you are even asking the question, you are the victim of a dead economist. Keynes’ theory was that the state should run contra-cyclical surpluses and deficits – to offset the ups and downs of the business cycle. But that is too soggy a bog for us to trod in today. Instead, we will skirt it with another of our dicta:

People come to believe what they must believe when they must believe it.

When an empire is new and fresh and growing…people believe in saving, hard work, and small frugality.

When an empire is old and decaying…they think the government should spend “whatever it takes” to take care of them. This attitude helps destroy the empire…thus making room for the next one.

But if America really wanted to protect its wealth, its power, and its position in the world, it should fight the depression in an entirely different way. Instead of bailing out failed businesses it should let them go bust. Instead of coddling the executives who mismanaged their companies, it should turn them loose. Instead of shoring up reckless banks, it should help knock them down.

And instead of spending money on stimulus programs…it should give money back to the taxpayers so they can stimulate the economy, or not, as they choose. Taxes should be cut in line with government spending. This would boost savings, reduce debt, and… gradually…increase investment and consumer spending too.

But that is not the road Americans have chosen. Instead, they found a president willing to go along with history. Instead of scaling down, he is scaling up. Instead of reducing America’s indebtedness, he is increasing it. Instead of going for safety, he’s going for broke.

No one knows how this will turn out, of course. None of us get to read the history books before they are written. But our guess is Mr. Obama will emerge from the tomes as another ‘great man.’ Doing history’s dirty work…he is continuing the destruction of America’s monopoly position on money and power.

Until tomorrow,

Bill Bonner

Source: Is America Overstretched?

You can explain the model in a few simple sentences: Encourage people to spend. When they run out of money, encourage them to borrow. When they tire of borrowing and spending, lend them more at lower rates.

As a way for people to build wealth, this economic model of the Bubble Period was as ineffective as a bad banker. It was a ‘have your cake and eat it too’ school of financial success with an obvious flaw. People noticed it when the correction began. They went to their cupboards and found there was nothing there. Homeowners – who had borrowed heavily against their houses – found their equity had disappeared. Capitalists found they had no capital. Workers lost their work.

And this year, governments’ tax receipts are collapsing too. In the United States, they’re down 14% in the first half of this fiscal year. Expenses, on the other hand, are exploding. This leads to a question: governments must borrow on a Herculean scale – but from whom? The United States is expected to float a record $2 trillion in I.O.Us. for 2009 – about 15% of GDP. If the downturn persists, as it has in Japan, we could see the U.S. national debt rise to Japanese levels – close to 200% of GDP.

In London, the numbers are smaller, but the math is the similar. The government has projected $175 billion deficits over the next two years. But this might be just the beginning. If deficits continue at this rate, Britain too could find itself back in the 1950s’ – after two world wars, with public debt at two times GDP.

What justifies such sacrifices? In time of war, citizens collect scrap iron…sell their jewelry…and buy bonds – anything to help pay for bullets and keep the Huns East of the Rhine. But what now? People clamp even bigger balls and longer chains on themselves…and for what? Taking flowers to the recovery room, they look in on the bubble model as though on a weary friend. “He supported us all,” says an anxious relative… “We must do all we can to save him.”

“Pull the plug,” is our advice.

Of course, when he was in his prime the bubble was fun – laughing, singing, spending…a grasshopper on stilts! And there were all those friendly ants in Asia ready to lend him money. At the peak, the U.S.A. had net borrowing of some $2 billion per day (trade deficit/365).

But now, take America’s anticipated budget deficit and divide it by 365. You get a figure of nearly $6 billion per day. Even at his peak, the old bug didn’t bring in that kind of money. And now, the foreigners are in recession too. They’ve got their own aches and pains to cure. So, how will the United States finance the biggest deficit of all time? How has Japan done it?

Japan’s economy has been locked up for 19 long years. It financed its confinement itself – drawing on the savings of a remarkably long-suffering population. Stimulus packages came and went. On average, they cost about 3% of GDP per year. The biggest came in 1998 – with a price of 6% of GDP. Financing this house arrest was easy – Japan began the period with a savings rate of 14% of GDP.

America, on the other hand, began with a savings rate of zero. More recently, the savings rate has been reported as high as 5% – as middle-aged squirrels desperately hide a few nuts for a long winter retirement. But the gods can add it up. Even if every dollar of U.S. savings is tossed down the public hole, it will still be two thirds empty.

Anticipating the problem, the Fed has already leapt into the hole itself. It offers to buy the government’s bonds itself. Of course, the Fed has no real money. It must ‘create’ money to make the purchase. It’s the latest miracle treatment, say the quacks in charge. If the Fed creates enough new money, it will offset the losses caused by the downturn. Then, happy days will be here again. The whole world seems to believe it. Stocks are rising. Ben Bernanke, this week, said the U.S. economy would recover before Christmas. The convalescence may be long, he continued, with his vision apparently restored; but it will be steady.

How the gods must howl! “In the Bubble Epoque people tried to get something for nothing… Imagine, they thought they could get rich by borrowing money and spending it. Have you ever heard of something so ridiculous? Ha ha! Now, they think they can get rich by spending money that doesn’t even exist.”

“But that’s not the half of it,” one of them is sure to notice. “They’re digging themselves deeper into debt – trying to revive the very oaf who pushed them down in the hole in the first place. Ha ha. Ha ha.”

Enjoy your weekend,

Bill Bonner

Source: Better Dead Than Alive