The subprime collapse is one symptom of years of little regulation, under-taxing, overspending, and massive debt. One way to understand what is happening in the United States is to look at what occurred time and again in Latin America and Asia, hotbeds of financial and banking crises. What we are living through happened time and again in Brazil, Argentina, and Mexico, as well as Korea and Thailand.

If there is too much debt, people lose confidence in the banks, then credit markets, currency, and government.

For more than a decade, the international financial cop, the International Monetary Fund, forecast a hurricane was heading toward US shores. As did many heads of the Treasury and the Fed. It is, to paraphrase a great writer, a chronicle of an agony foretold. There are five basic drivers of these crises, all based on excess: high income concentration, too much debt, too much reliance on foreign money, not enough tax revenue, and reckless government spending. Time after time governments believe they are different. They are bombarded by warnings but ignore, postpone, spend even more, and crash.

Over past decades, most US wages have fared poorly. Despite stagnant wages, consumer spending and debt increased, fueled by cheap credit. Companies also went on a debt binge. Careless deregulation allowed financial cowboys to run the system. Responsible CEOs who kept some cash, maintained moderate debt, invested for the long term, got pink slips. Financial chop shops did leveraged buyouts using a company's own cash and credit. To survive, companies piled on debt.

Many politicians decided reelection depended on cutting taxes and offering more benefits. Increase Medicare, postpone Social Security reform, hire more bureaucrats, and pay for a two-front war. Debt grew to pay for this party. These were not true tax cuts, just postponed debt; now we owe more and the bill has come due with interest.

Complicating this crisis is US economic hegemony. There were few places to park a lot of money. Despite the euro, European policies on debts and deficits are not much to brag about. So foreigners have gorged on US debt. The United States continues importing more than it exports. Middle Easterners and Asians who save and invest bought dollars for decades, but some of this money is now fleeing. The dollar has dropped sharply. Gold and oil have skyrocketed. In financial crises, huge pools of capital cross borders very quickly; a few can make a great deal of money shorting the country's currency.

The United States requires a massive restructuring to address its debt, cutting back on its borrowing, spending, and wars. The bailout package is essential to keep the credit markets open. But absent sentences that include the word austerity all the bailout will accomplish is a temporary postponement. Bailout and stimulus are a stopgap.

A solution requires the country to begin to spend what it earns, reduce its mountainous debt, and address massive liabilities, restructure Social Security, pension deficits, military, and Medicare. No wonder politicians would rather spend more of your money now rather than address these problems. Because we have been spending 5 to 7 percent more each year than we earn, a forced restructuring, triggered by a currency collapse, would have the same effect on wages and purchasing power that the housing collapse had on housing prices. So let's learn from our Latin and Asian friends and act before it is too late.

Regards,

Juan Enriquez and Jorge Dominguez
for The Daily Reckoning Australia

• Latin America Has Suddenly Become Very Interesting
• From Bubble Watch to Bust Watch
• Australia’s Response to the U.S. Bailout Plan
• The Bailout Debate Rages On
• Two Schools of Thought on the Bailout

It was a hot day in Paris. We sat outside in the galleries of the old palace. Near to us was another couple. Middle aged, they seemed like people who were getting together for the first time, not a couple who had been married for a long time. The man reminded us of John Malkovich. The woman? She was not an especially attractive woman, with straight gray/black hair cut as short as a man's. They held hands. They looked into each other's eyes. They seemed to be making plans for a happy future.

When you've been married for a long time, on the other hand, you have to wonder if your happiness is not more past tense than future. You can recall the happy times you spent together...how the children were when they were little...how much fun you had when you were poor and starting out in life...and all you went through together to get to where you are now. But when you look ahead, your weary eyes fail. You may feel as though you've said all you had to say - and agreed to disagree. You may feel as though the grand adventure of your lives has peaked out - like a bull market - with nothing but the downward slope left for you. You may feel that the great mystery of coupling has been revealed. Getting to know someone and getting together...even fusing your flesh, blood and spirit to form fully new human beings...is there anything left to discover? Are there more surprises coming?

Inevitably, the conversation turned towards the sovereign state of South Carolina. The poor state has a jackass for a governor. Mark Sanford has become a laughingstock for the entire nation. Not because he had an illicit dalliance and lied about it - who can honestly say he hasn't done that? - but because he is a cad. And the worst kind of cad - the kind who pretends to be sensitive and caring.

He's found true love, he says, with an Argentine beauty. But rather than dump his wife and fly to his heartthrob...he dumps the love of his life and tells his wife that he will try to fall back in love with her. The bonehead betrays them all - his wife, his lover...and love itself. He's even given romance a bad name. Meeting a woman who looks like Penelope Cruz on a dance floor in South America has an undeniable romantic appeal. When the story broke, there must have been hundreds of lonely middle-aged men in America booking their tickets and looking forward to tango. The Mark and Maria affair might have made the history books of star-crossed love, along with Tristan and Iseult, Antony and Cleopatra, Brad and Jennifer. But now, a week later, we know what kind of man Mark really is. Cancel the tickets. Any man who falls in love from now will feel like a sap.

As for us, we've been saps all our lives. Eventually, we'll head for the romance of Buenos Aires too. But we'll take our main squeeze with us, just to see what happens next.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Forgetful Bill
• All You Need is Love… and Work
• The Drunk at the Dentist Office
• Jules Begins His Last Year of School in Boston
• A Great Place for a House in Southern Maryland

Yesterday's issue of USA Today featured a report that said small businesses are going broke faster than expected. Small businesses are supposed to be the survivors. Like mammals in the Ice Age, they replace the dinosaurs. In a recession, big, costly, inflexible companies are supposed to get hit the hardest...leaving niches for small, nimble, low-cost competitors to slip into. These small businesses establish toeholds during the recession...hire people...and then scale up to the peak of commerce when the boom comes.

But this time it's different. Small businesses are collapsing along with big ones. In April, for example, more than small 8,000 businesses went broke and filed for Chapter 11.

In addition to the business bankruptcies are the personal bankruptcies. According to the Los Angeles Times, the rate of personal bankruptcy is soaring in Southern California.

In April, according to David Rosenberg at Gluskin Sheff, the feds added $121 million (at an annual rate) in total stimulus to the consumer economy - including tax reduction and increased benefits. In May, the total stimulus rose to $163 million. How come so many bankruptcies when the feds were giving away so much money?

The answer, says Rosenberg, is that consumers didn't spend the money; they saved it. Consumer spending rose just $1 billion April - despite $121 billion of stimulus. In May it rose $25 billion - despite a 'stimulus' 6 times that amount.

Meanwhile, the saving rate, which had been only 0.2% in March of 2008 exploded to nearly 7% in May 2009.

No consumer spending, no sales. No sales, no revenues. No revenues...no one can stay in business.

No small businesses. No new jobs. No new jobs, no economic recovery.

No economic recovery and the meddlers are back on the Hill asking for more power and money.

No surprise there.

Depressions take time. Bankruptcy rates don't rise overnight. First, it takes businesses a while to realize their sales are falling. At first, they think it might be a fluke. Then, they talk to friends and read the papers. And then, the next month confirms the story.

Then, it takes time for them to react. They have to figure out where they can make cuts. Typically, this involves layoffs and job losses. Employees who will be let go need to be identified. Then, they actually have to be sent home.

Then, the employee collects benefits. He looks for another job. He draws down savings. It takes time for him to react too. He watches. He notices that it is hard to find another job. He realizes his resources are running out. He begins to cut back. Unnecessary expenses are eliminated. Then, he broadens his definition of 'unnecessary.' Finally, he lacks the money for the essentials. The mortgage goes unpaid. Credit card deadlines are missed. This provokes an inevitable response - warnings, more warnings, official action, and finally...defaults, foreclosures and bankruptcy filings.

We expect unemployment and bankruptcy filings to edge up throughout the summer months. Then, by the autumn, asset prices should be going down again.

Bill Bonner
for The Daily Reckoning Australia

• If the US Economy is Really Following Japan Things Will Get a Lot Worse
• Job Losses From Private-sector Rose Since Beginning of Recession
• Consumer Confidence is at its Lowest Point Since 1980
• Rosenberg Let His Clients Know He Thought the Sucker’s Rally Was Over
• IMF Gold to be Used

Let's begin with the stimulus/bailout/boondoggle/BS plan. As anticipated, it has failed. That is, the economy is getting worse, not better. It has failed the test set for it by its own creators. Back when the Obama Team was arguing for a big bailout bill, it warned that without a bailout, unemployment would rise above 8% in 2009. 'Pass this bill today,' said Ben Bernanke, or words to that effect, 'or there may not be a tomorrow for the US economy.'

Congress dutifully bent its back to the task of adding boondoggles to the bill and then okayed the measure. And here we are, in the middle of 2009, and the unemployment rate is already at 9.4%.

Even at the time, it was obvious that the hacks in the administration had no idea what was going on. They were just guessing about the economy and taking advantage of the situation to pass out more money that taxpayers hadn't even earned yet.

As predicted, the spending didn't make the situation better; if anything, it probably made it worse - by delaying the process of destruction, and hence retarding the process of creative reconstruction too.

We recall our other forecast too: when the bailout doesn't work, they'll pass another one. And so, in yesterday's New York Times, there is David Leonhardt urging the pols to even bigger acts of absurdity:

"The economy really may need more help," he says.

Yes, it will need more help. Especially if it keeps getting the kind of help it's been getting.

The stock market is acting more or less as we thought it would too. The big bounce began on the 9th of March. It's been almost four months now...and the bounce should be getting near its peak...and beginning to fall again. Just look at a chart of the Dow since March. You'll see exactly that. Like a cannonball, it went up...and now it seems to be arching over for its fall to the ground.

Yesterday, the markets seemed to hang in mid air... The Dow was up 57. Oil stayed at $69. Only gold seemed to know where it was going - rising $13.

Bill Bonner
for The Daily Reckoning Australia

• If the US Economy is Really Following Japan Things Will Get a Lot Worse
• Investors Feel They Can Put Their Money into Treasuries and Not Worry
• Government Intervention for Economy Makes Things Worse
• Wall Street Gets the Boot
• The Stinging Reproach of a Former Fed Chairman

The U.S. Labor Department Reported that around 467,000 Americans lost their jobs in June. This was unwelcome news. The data had been getting less bad every month since January. Then the June numbers rocked up, fell out, and took stocks down with them. This is causing everyone with a pulse (and most with a brain) to have second thoughts about just how good things are-or how much worse they might get.

The S&P and the Dow both fell nearly three percent. Oil and gold were down too. About the only thing up were Treasury bonds and notes. Speaking of which, the U.S. will auction another $73 billion of those next week. Wednesday's auction is for $19 billion in ten-year notes while $11 billion in 30-year bonds go on sale Thursday.

The Aussie futures are pointing to an open about two percent lower on the S&P ASX/200. And why wouldn't they? If the jobless rate in American-9.5%--has reached a 26-year high, might that mean Australia's labour market (the whole economy even) is in danger of swooning again?

"You may have green shoots, whatever you want to call them, you may have temporary relief, but you are still in a world that's breaking," Black Swan author Nassim Taleb told CNBC's Squawk Box. "Anything that's fragile like the financial system will eventually crash, he said...We're in the middle of a crash...So if I'm going to forecast something, it is that it's going to get worse, not better."

Taleb's point is not a popular one. But it is a realistic one. The fiat money, leveraged finance Western financial system went global in the last twenty years, providing an epic rise in asset prices (and the debt used to purchase them). There's no doubt that real goods and services have traded hands with world growth. But now we wonder how much of that is sustainable when you take the credit away.

Did we use phoney money to build a world with completely unrealistic levels of growth? Were trillions of dollars of capital allocated based on final demand that was artificially pumped up by credit, currency manipulation (low U.S. interest rates and global dollar pegging), and government stimulation?

Yes we did!

Mind you, the crash of the financial system is not the end of the world. It is a massive calamity to be sure, wiping out the value of retirement assets many people were counting on to make it through their golden years. But as many readers have reminded us in the last few months, there is more to life than money.

Fair enough. But there is more to wealth than money too! Peace of mind, having your assets in forms that can't be inflated away or won't suffer from debt deflation...we would count these as "wealth" at a time like this.

That brings us back to the problem growing at the back of our mind yesterday. Can a massive deflating credit bubble nullify the liquidity measures by central bankers, which are puny in comparison to the nominal value of the assets at risk? "Yes you can!," comes the answer from some of the friends we put the question to.

"I'm tempted to disagree that expansion in govt credit won't reach the economy and therefore won't be inflationary," replied Money Morning editor Kris Sayce. "I'm not mistaken, the Fed is buying up these 'assets' in order to take them off the banks and also to help price them. If the Fed didn't do this then the banks wouldn't be able to lend extra money to customers as they would breach their lending limits."

"It's not so much that the Fed is directly feeding the banks money which flows through to the economy, it's more that the Fed is feeding the banks money which allows them to expand lending which they otherwise wouldn't be able to do. Thus at the very least is preventing prices from falling, or from falling as much as they ordinarily would without the intervention. In effect there is more money flowing in than there otherwise would be. There already IS inflation."

Another colleague in the States replied that, "I am leaning more and more to the idea that the credit-based stuff will deflate (real estate, stock prices) but the cash-based stuff could rise (like foodstuffs, energy). In a way, it's not a debate about inflation or deflation, but which assets inflate and which deflate. There might be a strong dichotomy within the economy between the two."

To the extent that you cannot eat a mortgage-backed security, we see the wisdom in this view. The world has a lot of people. They have a lot of real needs. Regardless of the value of derivatives and opaque financial assets, a certain level of economic activity for a certain kind of tangible good will still be there. The challenge for investors is to determine if you can profit from this in traditional ways (stocks and bonds) or if you have to venture into less traditional asset classes and forms of ownership (land, real commodities, precious metals).

And of course, the thesis could be incorrect. If credit is not money-or if the large lending and government guarantee programs don't reignite a lending boom in the real economy-then you may simply see a lot of wealth disappear down the memory hole.

Finally, a mystery Aussie commentator who wishes to remain anonymous but whom you may hear from in the future in this space sent a philosophical yet practical reply.

"What is money? Currently, that's what the Federal Reserve (and other central banks) put in the reserve accounts of their member banks. The banks then use this as a base to create their own money, or 'like money'. I guess this is also known as credit. So yes, credit is not money.

"And this bank credit is now contracting as the natural force of the market tries to drive prices lower and correct the boom. The Fed is offsetting this process by swapping 'money' (fed funds) for the impaired assets. But the banks are sitting on the cash, and obviously do not have the risk appetite (or the demand) to lend it out."

"So at this point additional base money is not being lent out as inflationary 'like money'. I'm not sure the Fed has the mechanism to make out and out purchases of assets other than through lending facilities, unless they are Treasury or Agency purchases. As far as I'm aware, the Fed can only distribute its newly created money through the banking system, and no other way. The banks have always been the source of inflation, and then need to lend to create this. They will probably use their excess reserves to buy Treasury's in the coming years, and then the Fed can but the Treasury's back off them in time. This will be inflationary."

"Where does gold come into it? Well, gold is real money....chosen independently by the people. As trust in the US dollar continues to evaporate, demand for gold will increase. At some point gold will again be referred to as money. Because the amount of credit (debt) in the world dwarfs the amount of gold, and because gold will be a legitimate extinguisher of the debt, gold will likely rise massively to have the capacity to extinguish the debt. This is a process unfolding over years though.

"A rising gold price is actually deflationary in that it represents a rise in the purchasing power of money. So I think deflation is the ultimate force that cures this massive credit bubble...outright deflation if long term faith in the US dollar remains, or gold price induced deflation should the bottom fall out of US dollar trust. The quantity of US dollars may be rising at the moment but the real turning point will be when the perceived quality of the dollar declines."

Hmm. Gold rising indicates the rising value of cash...because gold is money. But if money is not wealth...and gold is money...does this mean gold is not wealth? Now there is something to think about over the weekend. Our thoughts on Monday...

Dan Denning
for The Daily Reckoning Australia

• Gold is the Oldest Form of Wealth
• Broad Money Supply Declines by $50B in US, Fire Up the Printing Presses
• The Actual Money Supply
• Transfer of Wealth
• What Inflation Means to Central Bankers, Investors and the Consumer

The current economic crisis, which was instigated by the government's central bank and its boom-and-bust monetary policies, among other interventions, has once again been blamed on "too little regulation" and too much freedom.

Will Americans ever catch on to this biggest of all of government's Big Lies?

When the Pilgrims came to America, they nearly starved to death because they adopted communal agriculture. When William Bradford, leader of the Mayflower expedition, figured this out he reorganized the Massachusetts pilgrims in a regime of private property in land. The incentives created by private property promptly created a dramatic economic turnaround and the rest is history. Most history books ignore this reality, however, and blame the starvation crisis of the Pilgrims on corporate greed on the part of the Mayflower company.

After the American Revolution, it was imperative to build roads and canals so that commerce could expand and the economy thrive. George Washington's Treasury secretary, Alexander Hamilton, declared in his famous Report on Manufactures that private road and canal building would never succeed without government subsidies. President Thomas Jefferson's Treasury secretary, Albert Gallatin, concurred. Meanwhile, private capital markets and the private "turnpike" industry were busy financing thousands of miles of private roads without any governmental assistance. When government did intervene in early-American road building, it was a financial catastrophe almost everywhere, so much so that by 1860 only Missouri and Massachusetts had not amended their state constitutions to prohibit the use of tax dollars for "internal improvements."

Americans have been taught by their government-run schools that the post-1865 Industrial Revolution was bad for the working class, which made government regulation of work and wages, and the creation and prospering of labor unions necessary. In reality, people left the farms for factories because the latter offered far better wages and working conditions. Between 1860 and 1890, real wages increased by 50 percent in America, as myriad new products were invented, and made available to the common working person thanks to low-cost, mass production. It was capital investment that dramatically increased the productivity of labor, allowing hours worked to decline from an average of 61 hours per week in 1870 to 48 hours by 1929.

Higher worker productivity, fueled mostly by capital investment by entrepreneurs and private investors, also made it less necessary for families to force their children to work. Child labor was on the wane for decades before government got around to regulating or outlawing it. And when it did so it was to protect unionized labor from competition, not to protect children from harsh working conditions.

The "robber barons" of the late 19th century robbed no one. Most of them made their money by providing valuable - if not revolutionary - goods and services to the masses at lower and lower prices for decades at a time. John D. Rockefeller, for example, caused the price of refined petroleum to drop from 30 cents per gallon in 1869 to 8 cents in 1885, and continued to drop his prices for many years thereafter. James J. Hill built the most efficient and profitable transcontinental railroad without a dime's worth of government subsidy. In return for their remarkable free-market success the government prosecuted both of these men, kangaroo court style, under the protectionist "antitrust" laws. The real "robbers" were politically connected businessmen like Leland Stanford, a former California governor and senator, who succeeded in getting laws passed that granted his company a monopoly in the California railroad business.

The federal antitrust laws were passed beginning with the Sherman Antitrust Act of 1890 because the government informed Americans that industry was becoming "rampantly cartelized" or monopolized. In reality, prices everywhere were plummeting as new products and services were being invented everywhere. The entire period from 1865 to 1900 was a period of price deflation. As I show in How Capitalism Saved America, all of the industries accused of being monopolies by Congress in 1889- 890 had been dropping their prices for at least a decade thanks to vigorous competition. And it was not a result of the idiotic theory of "predatory pricing." No sane businessperson would intentionally lose money for decades by pricing below cost with the hope that he would somehow frighten away all competition forevermore.

Everyone "knows" that President Herbert Hoover was a staunch advocate of laissez-faire economics, and it was his lack of interventionism that caused the Great Depression. This is the biggest governmental lie in the history of America. Hoover was a "progressive" (as today's socialists, also known as "Democrats," have taken to calling themselves).

Hoover strong-armed corporate executives into raising wages at a time when wages needed to adjust downward in the free market in order to minimize unemployment. He devoted 13% of the federal budget to a failed "stimulus" program of pork-barrel spending and imposed some of the biggest tax increases in history to fund it all. He was a protectionist who signed the notorious Smoot-Hawley Tariff Act, which increased the average tariff rate to nearly 60 percent and spawned a worldwide trade war that shrunk world trade by two-thirds in three years. He cartelized the agricultural industry with "farm boards" that began the insane practice of paying farmers for not growing crops or raising livestock. He pioneered the politicization of capital markets by creating the Reconstruction Finance Corporation. And he ranted and raved against "greedy capitalists" while launching numerous government "investigations" of investors and the stock market. FDR's top domestic advisor, Rexford Tugwell, said that his fellow New Dealers "owed much to Hoover," who began many of the policies that they simply extended.

Every time the price of gasoline goes up significantly, Congress convenes a Nuremburg Trial-style inquisition of oil-company executives. This practice began in the 1970s when the government's own foolish price controls on petroleum products caused massive shortages, and it needed someone to blame. Oil company executives are never praised when gasoline prices fall, as they have in the past year from over $4/gallon to under $2/gallon in many parts of the United States.

Most recently, the current economic crisis is said to be caused by the "excesses" of economic freedom and "too little regulation" of the economy, especially financial markets. This is said by the president and numerous other politicians, with straight faces, despite the facts that there are a dozen executive-branch cabinet departments, over 100 federal agencies, more than 85,000 pages in the Federal Register, and dozens of state and local government agencies that regulate, regiment, tax, and control every aspect of every business in America, and have been doing so for decades.

Laissez-faire run amok in financial markets is said to be a cause of the current crisis. But the Fed alone - a secret government organization that is accountable to no one and which has never been audited - performs hundreds of regulatory functions, in addition to recklessly manipulating the money supply. And it is just one of numerous financial regulatory agencies (the SEC, Comptroller of the Currency, Office of Thrift Supervision, FDIC, and numerous state regulators also exist). In a Fed publication entitled "The Federal Reserve System: Purposes and Functions," it is explained that "The Federal Reserve has supervisory and regulatory authority over a wide range of financial institutions and activities." That's the understatement of the century. Among the Fed's functions are the regulation of

• Bank holding companies
• State-chartered banks
• Foreign branches of member banks
• Edge and agreement corporations
• US state-licensed branches, agencies, and representative offices of
  foreign banks
• Nonbanking activities of foreign banks
• National banks (with the Comptroller of the Currency)
• Savings banks (with the Office of Thrift Supervision)
• Nonbank subsidiaries of bank holding companies
• Thrift holding companies
• Financial reporting
• Accounting policies of banks
• Business "continuity" in case of an economic emergency
• Consumer-protection laws
• Securities dealings of banks
• Information technology used by banks
• Foreign investments of banks
• Foreign lending by banks
• Branch banking
• Bank mergers and acquisitions
• Who may own a bank
• Capital "adequacy standards"
• Extensions of credit for the purchase of securities
• Equal-opportunity lending
• Mortgage disclosure information
• Reserve requirements
• Electronic-funds transfers
• Interbank liabilities
• Community Reinvestment Act subprime lending requirements
• All international banking operations
• Consumer leasing
• Privacy of consumer financial information
• Payments on demand deposits
• "Fair credit" reporting
• Transactions between member banks and their affiliates
• Truth in lending
• Truth in savings

That's a pretty comprehensive list, the result of 96 years of bureaucratic empire building by Fed bureaucrats. It gives the lie to the notion that there has been "too little regulation" of financial markets. Anyone who makes such an argument is either ignorant of the truth or is lying.

Regards,

Thomas DiLorenzo
for The Daily Reckoning Australia

• How Will the Next President Handle This Dire Economic Crisis
• Why Inflation Or Hyperinflation Lies in Wait for the U.S.
• Admonishment from China and the Decline of U.S. Credibility
• Government Guaranteed Depression?
• Millions of Zimbabweans Face Starvation due to Nationalisation caused by Hyperinflation

It was a sparkling affair...with hundreds of attendees dressed in black tie and gowns. There were showgirls too - dressed in a pert '20s style...somewhere between the Great Gatsby and the Ziegfeld Follies. Short, tight dresses with shimmering fringes...hats with feathers...the girls served champagne and did dance numbers.

"I see the publishers association has chosen a '20s theme," began the emcee. "What is wrong with you people? Don't you know what came after the '20s? The '30s!"

It doesn't seem like the '30s...yet. Ask the man on the street and he will tell you what he's heard on TV: the worst of the crisis is over.

According to Bloomberg: "Wall Street's largest bond-trading firms say the worst may be over for investors in Treasuries after government securities posted their biggest first-half losses in at least three decades.

"The 16 primary dealers, which trade directly with the Federal Reserve and are obligated to bid at Treasury auctions, forecast the benchmark 10-year note yield will finish the year little changed at 3.58 percent, after rising from 2.21 percent at the end of 2008, according to a survey by Bloomberg News."

Stocks will keep going up until 2010, says money manager John Dorfman. The "crisis management" phase is behind us, says Jeff Immelt.

But this only reminds us of...1930. Let us wake up the ghosts just so we can laugh at them:

"The spring...marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity," Julius Barnes, Head of Hoover's National Business Survey, March 16, 1930.

"We are now near the end of the declining phase of the depression," the Harvard Economic Review, November 15, 1930.

In 1930...as in 2009...the average fellow thought the crisis had passed.

"Well...depression wasn't so bad," he said to himself.

Is it possible that the credit expansion that began after WWII and lasted until 2007...taking the debt-to-GDP ratio from about 150% to 360%...has contracted in the space of 24 months? Have the mistakes of the Bubble Epoque been corrected already? Are household balance sheets back in balance?

The markets continue their daily hum...

The Dow fell 81 points yesterday. Gold dropped $12. Oil traded at $69. And bonds fell a little - the 10-year yield rose back above 3.5%.

Meanwhile, the economy continues its work...correcting...paring...amputating...discarding...destroying the illusions of the bubble years...to bring things back in balance.

"Gloomy US consumers clip housing recovery," begins a Reuters article. Another report, at MarketWatch, blamed the gloom on a "gloomier jobs view."

Housing and jobs are the two cornerstones of American middle class wealth. If they can't hold the weight of a building economy, there is little chance of a broad recovery in the United States...or Britain.

"Last week, I hosted a meeting of mortgage lenders," continued last night's emcee. "They got together all the mortgage lenders in Britain who are still in business. I felt sorry for the guy. All alone...

"Today, a guy goes into a bank and he says... 'I'd like to talk to you about a loan...' and the banker says to him, 'Great...how much can you lend us?'

Net mortgage lending in Britain is the weakest it has been since they began keeping records in '93. And today's news tells us that the UK economy is shrinking faster than people thought. In the first quarter, the UK GDP fell by 2.49%.

In Britain as in America, the real economy is falling off just as investors, analysts, and commentators think they see a recovery. They think rising stock prices - US stocks are up 40% since March 9th - predict and precede a growing economy. Stocks, they say, "look ahead."

People will believe anything. If stocks had been watching where the economy was going they never would have traded at such high levels in '07. They clearly had no idea what was ahead. Nor do they now.

The images of the '30s keep coming back. TIME has put Franklin Roosevelt's picture on its cover, as if he were the man of the hour now.

Americans think they are confronted with a challenge, which...with proper leadership...they will overcome. Madoff has been locked up; now it's just a question of beefing up those regulators so it doesn't happen again. The stimulus packages have been set up; now we just have to wait for them to do their work. The Fed has done its part too; it's just a matter of time until all that money and credit it put into the banking system turns up in the consumer economy.

And Obama...isn't he just like Roosevelt? Isn't he taking advantage of this crisis to help build a stronger...fairer...US economy?

If you read the papers you might think so. In The New York Times, Felix Rohatyn, has written a remarkable essay - remarkable in the sense that he has managed to take up 2/3 of a page without saying anything. To help him do so, he calls on the first Roosevelt, Theodore: "He insisted on government's obligation to regulate the large new business aggregations not so much to address the inequalities of wealth as to police its potential distorting influence...to reinforce the new system, not weaken it."

Mr. Rohatyn goes on to advise Obama:

The work ahead, he says, "will require difficult and painful actions, which can only come from a multi-year, bipartisan plan, led by the president and the Congress, with the support of business and labor."

Blah, blah...blah... What he is urging on the nation is more central planning - with no idea how or why central planners will be better at controlling other peoples' money than people are at controlling their own. And imagine the 'plan' that would have the support of politicians of both parties, business interests and labor; it's bound to be a disaster - like all of Teddy Roosevelt's plans.

But it's the other disastrous Roosevelt that catches most looks. The one on the cover of TIME magazine. This was the Roosevelt who, with the help of Herbert Hoover, turned the correction of the early '30s into the Great Depression. Rather than let the markets quickly correct the mistakes of the '20s, he tried to put them in a straitjacket. And rather than let people sort out their own finances, he set up a huge bureaucracy to bring Mussolini-style central planning to America. That bureaucracy is still with us - including Fannie Mae, which was instrumental in creating the housing bubble...and the SEC, which was instrumental in camouflaging the risks of in the investment markets.

But there's no point in going on about the two Roosevelts. TIME and the nation believe they were great heroes who practically single-handed saved the country from destruction. No use trying to tell them anything different.

So, instead...we will continue our lonely vigil - watching to see what mischief these clowns undertake next...and how we might protect ourselves...

What we see is this: the United States prospered in the 20th century not because of the Roosevelts, but in spite of them. The American economy was expanding... it was still young, strong, competitive and prosperous. The empire grew with economic power.

But the years ahead are not likely to resemble the post-Roosevelt years. America's position relative to the rest of the world is weak and in decline. She is not a creditor, she is a debtor. She is not a low- cost competitor; she is a high-cost competitor. She no longer has a free and flexible economy; she has one freighted with central planners, regulators and busybodies.

There is a heat wave here in London. At least, that is what you would think if you listened to Londoners.

"I can't take this heat," said a friend yesterday. It didn't seem that hot. Compared to Maryland in the summer, it seemed like a winter day. We checked the headlines:

"80 Degrees again tomorrow," said one. "No relief in sight."

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Irving Fisher Remains Immensely Important in the History of Economic Thought
• Irving Fisher Has Come Back Into Fashion
• Recessions Can be Short, Medium, Long, Mild, Medium or Severe
• President Barack Obama and Franklin Roosevelt Are Becoming Akin
• Politics and Investment Intertwined

But the task of today's Daily Reckoning is not to figure out where stocks are headed in the second half of the calendar year. No one knows. Our strategies are focused on energy stocks-both the conventional and highly unconventional kind. We're bearish on fixed income, a bit more bullish on cash, precious metals, and tangible assets.

What about housing? ANZ Bank published a report on the subject yesterday. Among other things, it declared that, "We expect dwelling prices to edge higher for much of the remainder of 2009 with upside risk presenting from intensification of strong fundamentals, a shift in price expectations and restoration of confidence."

Pardon?

That is some seriously tortured syntax. What does "upside risk presenting from intensification of strong fundamentals" actually mean? Does that mean there is a risk prices could go up? Blah blah blah.

On the plane to Adelaide yesterday we had a much more down to earth conversation about property with the man sitting next to us in the exit row on our Boeing 737. He was reading a story in yesterday's Australian about the new "boom in the bush."

"According to RP Data-Rismark, the national median house price of $468,819 is just $520 shy of the record set in February last year, before the global economy sank into recession. Melbourne is leading the housing recovery, with a 6.1 per cent growth in prices between January 1 and May 31 and auction clearance rates in excess of 80 per cent for the past seven weeks. Sydney recorded 5.2 per cent growth in prices over the same period."

Adelaide was not near the top of the list. And that had this passenger concerned.

"My wife and I decided to buy another property about 18 months ago. We thought the financial crisis was a good buying opportunity. You had a lot of people scared. But now, I just want to get rid of the thing. It's keeping me up at night."

"But I've heard Adelaide is a nice place to live."

"It's lovely. But I bought around $410k and already the median price is below that here. I don't care what I get now. I'd be happy with $408. I'm going to call my agent and let him know. My wife tells me I'm being silly. But I just want out. I have my pay stubs from back when I bought my first house and I have the mortgage too. I made $8,000 a year and the house was $25,000. Today, though, we need that money for retirement...I don't wanna be caught selling when everyone else is. I want out."

It sounded like he wanted out of the market.

"I get worried when people saying prices always go up. I mean there must be some evidence to show that isn't true. Wouldn't people want to know that before they took out a big mortgage...especially with interest rates. They have to go up sometime don't they?"

Your editor didn't say much because he was nodding the whole time. Choir, meet preacher.

Of course this preacher and this choir may be excommunicated from the Church of Aussie Housing. Median home values are within shouting distance of their all-time highs, thanks for the first buyer's grant. It's a disaster in the making.

Demographics, immigration, the concentration of the population in urban centres, and the much ballyhooed supply gap are all trotted out as reasons why house prices always go structurally higher in Australia. This also explains, apparently, how Aussie house prices can defy household earnings gravity.

That is, people spend much larger multiples of their income on housing here than anywhere else in the world. How is that affordable? A reversion to the mean ratio (3:1) would mean a serious correction/crash. That seems impossible and psychologically impermissible to a lot of Aussies. But once you wrap your head around the idea that, historically, house prices don't go up much faster than the rate of inflation, it begins to make sense.

There may be multi-year periods (we call them credit bubbles) when low interest rates create a boom in mortgage lending. This leads to house price inflation. But those booms always go bust.

Governments seek to avoid the bust by reigniting another round of inflation to keep household nominal wealth from utterly collapsing (or simply reverting to a more sensible mean). Hence, the Aussie government sparking a lending boom to those people in Australia with the most to lose from taking on huge mortgage at the low end of the interest rate cycle; young Aussies who are the most vulnerable workers in the job market and spend the highest percentage of their discretionary income (not much) on an asset they bought at the top of the boom.

Come to think of it, if you were deliberately trying to wipe out the financial prospects of an entire generation by saddling them with crushing debt, increasing the first buyer's grant is probably exactly what you'd do. And you'd laugh along with your banker friends.

Incidentally, two of our confirmed panelists for the Debt Summit later this month will have a lot to say about Aussie property. Stay tuned.

Finally, some reader mail. It raises a problem that's been growing in the back of our brain. Credit is not money. So what happens if the credit bubble deflates and the liquidity measures (which are not money) instituted by the Fed and other central banks never turn into new money supply. Does this invalidate our entire position on inflation, and the investment strategy that goes with it? No! More on why tomorrow.

--Dear DR,

David W.

Dan Denning
for The Daily Reckoning Australia

• American House Prices Continue to Fall While the Same Can’t Be Said About Australian House Prices
• RBA Buys $780 Million in Residential Mortgage-Backed Securities
• Aussie Housing Market Actually Leads the U.S. by Three Years
• Australian House Prices Are Severely and Seriously Unaffordable
• House Prices Down and Aussie Market Enters Second Wave of Rebound Rally

People in other countries are beyond such simple mechanisms of control. For an international currency, there must be reasons to use the currency voluntarily.

The best currency is the one that is most stable in value. Historically, the premier international currencies, whether the US dollar after World War II, the Dutch guilder in the seventeenth century, or the Athenian owl in the fourth century BC, were those reliably pegged to gold. Gold has been the superlative monetary standard for thousands of years.

Even after the US dollar left the gold standard in 1971, it remained the most stable currency in the world, which allowed it to maintain its prominence up to the present day. There was no better alternative.

During the 19th century, the US was considered an emerging market. The premier international currency was the British pound.

In 1914, the British pound had been pegged to gold (with brief lapses) for 233 years. However, the beginning of World War I tossed all the European powers into turmoil, including Britain. The pound's link with gold was broken. People in Europe looked for a reliable store of their financial assets. They observed that the United States was untroubled by war and had by then a long history of gold-linked currencies and protection of property rights.

In the 1930s, all European governments devalued their currencies again. The United States did as well, in 1933, but the dollar remained pegged to gold afterwards while most European currencies (and the yen) floated. World War II cemented the transfer of financial prominence to the US To put it quite simply: the US Treasury bond - denominated in gold-linked dollars - was the most reliable store of value in the world.

Financial theorists divide the world of investments into two asset classes: the risk-free asset, and all other risky assets. With currencies mismanaged constantly by central banks, nothing today even approaches the ideal of a "risk-free asset." In marketing-speak, a vast demand goes unsatisfied.

How could China establish an international currency? I predict it will happen when a person anywhere in the world is able to say: The Chinese government bond is the most reliable store of value in the world - the closest approximation to the "risk-free asset."

Obviously, we are not there yet. How could the Chinese government promote this process?

The Chinese yuan would have to be reliably stable in value. In the past, this has always meant a gold standard. Fiat floating currencies managed by bureaucrats are never very reliable, and have a nasty tendency of disappearing altogether. In the past, the international currency was always the one that remained pegged to gold, while the alternatives sank into chaos and devaluation.

Chinese authorities may claim that their floating currency managers are better than the US or European floating currency managers, but nobody would believe them.

The yuan would have to be a reliably independent alternative to the dollar, euro or yen. Since 1950, the yuan has had one form or another of a dollar peg. It is completely pointless to use yuan instead of dollars, if the yuan is pegged (tightly or loosely) to the dollar. The desire for stable exchange rates is entirely reasonable. However, the Chinese government has not established any record of being able to manage an independent currency.

Simply having a floating currency is not enough. Both the euro and yen float, but they are not really independent of the dollar. Monetary policies at all three central banks are eerily similar. The Bank of Japan, in particular, seems to be subject to political pressure from the United States. If the dollar were to fall in value considerably, it is likely that the euro and yen would also be guided lower to avoid disadvantages to trade. They would all decline together, if not quite at the same speed.

To put it a slightly different way: Even though people are getting nervous about the reliability of the US Treasury bond, neither the German government bond nor the Japanese government bond are clearly better.

If China adopted a gold standard policy, this would establish true independence from the dollar. However, if the dollar fell in value considerably, then the yuan/dollar foreign exchange rates could change dramatically. Instead of about 7:1 today, perhaps it could go to 1:1 in the future. This would be due to a dollar fall, not a rise in the yuan.

Many countries could not tolerate such a situation. Switzerland tried, in the early 1970s, but the trade consequences were too great. It would be quite unpleasant for China as well. However, China already has significant trade advantages, so even large forex moves like this could be withstood.

The Gulf States - and Russia to some degree - have an even larger advantage in this regard. They have no real competition for their primary export, crude oil.

A credible military remains, unfortunately, an important component of political independence, and consequently currency independence. The US is not likely to hand over its mantle of world leadership without complaint. While hostilities are unlikely, certain political pressures by the US can be imposed upon governments who, in schoolyard terms, seem like they can be pushed around. Japanese leaders remember the military exercises the US Navy conducted in Tokyo Bay in 1989, a rather blatant reminder of the Black Ships of 1853. Russia is well aware of political incursions in the former Soviet republics, and even Germany still hosts enormous US military bases.

China is establishing itself as a military power. An alliance with Russia, and acquiescence among the other Asian states, would help establish real political independence.

There remains a little problem of exactly how to manage a gold standard system. This is not very difficult, but the Chinese monetary authorities apparently have not yet mastered the basic concepts involved. Fortunately, there is now a handbook on these subjects - Gold: the Once and Future Money (2007), which is available in a Chinese edition.

The US dollar is, quite frankly, not a very good currency. It would not be difficult to develop a better alternative - a currency pegged to gold. Once the Chinese authorities had demonstrated that they can manage such a system, people everywhere would flock to yuan-denominated assets. Lenders would demand that their loans be denominated in reliable, gold-linked yuan. Shangahi would become the financial capital of the world.

Regards,

Nathan Lewis
for The Daily Reckoning Australia

• A New Bretton Woods Vs. The Old Bretton Woods
• An International Currency Not Just on Paper
• A Gold Standard, Without Gold
• Debunking Inflation Myths
• David Ricardo’s Economic Theory is Sound Doctrine

As we remarked above, we're suckers for underdogs, die hards and scalawags. That is probably one of the reasons we like Argentina; it is all those things and more. It is a measure of the lost cause status of the pampas that news of the election was hard to find. We looked through the TIMES and found no mention of it. The International Herald Tribune did pass along the news - on page 4.

Something went wrong in Argentina. The country was once a rival of the United States of America - with nearly the same income per capita...and about the same prospects. Now, it has less income per person than Chile and exports less beef than its tiny neighbor, Uruguay.

What went wrong?

Well, life is not exactly under our control. We doubt that a group of Argentines ever got together and decided to become a second rate country. Things happen.

And here at The Daily Reckoning we watch...and wonder what will happen next.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

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