Just last week, Team Obama took its financial-crisis dog-and-pony show on the road. U.S. Treasury Secretary Timothy F. Geithner went to China. Federal Reserve Chairman Ben S. Bernanke visited Capitol Hill. And President Barack Obama, himself, embarked on a Mideast tour that started in Saudi Arabia.

This full-court press is not coincidental, and comes just as the federal government began unloading trillions of dollars in new U.S. Treasury obligations. The coordinated charm offensive is meant to assure the world-at-large that the United States can repay these obligations – without destroying the dollar.

Given the renewed weakness in the dollar and the recent expressions of concern from China—our largest creditor—about the safety of its current holdings, this is no easy sell. Not only must our leaders convince holders of our debt not to sell what they already own, U.S. officials must persuade these same foreign investors to back up the truck and buy a whole lot more. The hope is that a Dream Team – consisting of a charismatic politician, a skilled Wall Street banker with longstanding ties to China, and a respected Fed chairman – can close the deal. However, no matter how slick the sales pitch, no amount of lipstick can dress up this pig.

The most obvious fear the trio must address is that oversized deficits will persist indefinitely. Reading from a carefully scripted rebuttal book, all three proclaim that as soon as the stimulus revives our economy, the government will take all necessary steps to reign in the deficits that result. Bernanke’s testimony showcases this rhetorical shift. The Fed chairman claimed that catastrophe has been averted and that the recession is nearly over. As a result, he advised Congress to now focus on debt management. How he expects U.S. lawmakers to do that was left unexamined.

Setting aside the fact that the recession is far from over and that the stimulus will actually weaken the economy in the long run, Bernanke’s words were less a practical guide to Congress than a bromide for our foreign creditors. Meanwhile, President Obama carefully peppers his speeches with calls for Americans to live within their means, to save more and spend less, to produce more and consume less. But nothing in the government’s current fiscal or monetary policy will encourage such behavior. In fact, the objective of economic stimulus is to prevent such changes from taking place!

The laughter of Chinese students that greeted Secretary Geithner at Peking University shows how ridiculous this spiel sounds overseas. Actions speak louder than words, and the actions of the Obama administration are deafening. Multi-trillion-dollar deficits, bailouts, nationalizations, quantitative easing, and grandiose plans for government-provided healthcare, education, and alternative energy, render all of the administration’s claims of future prudence meaningless. If our leaders will not make tough choices now, why should anyone believe they will do so later, when those choices will be even harder to make?

Of course, it’s not just major holders – such as China and Saudi Arabia – that need to be convinced. Since the largest holders are already in so deep, they have the greatest short-term incentive to play ball. While throwing good money after bad is certainly a lousy investment strategy, it is politically expedient as it delays the need to officially acknowledge losses.

The spin is designed to keep all the smaller, more nimble holders from dumping their U.S. Treasury securities. The major holders can publicly pledge their commitment to Treasuries, while they privately planning their exit strategies, as long as they feel that the smaller holders won’t spook the market by front-running their trades.

However, once the psychology turns, there is no way to stop the rush for the exits. Remember how quickly the secondary market for subprime mortgages collapsed? One day, investors were lining up to buy; the next day, the stuff couldn’t be given away.

Make no mistake about it, we are issuing subprime paper and no amount of political spin can alter that reality. Bogus credit ratings aside, I think the world already knows this and it’s just a matter of time before someone admits it.

In the meantime, by continuing to lend, our creditors merely supply us the shovels to dig ourselves into an even deeper economic hole. Their credit enables our government to grow when it needs to shrink, finances bailouts of companies that should be allowed to fail, and enables a nation that should be saving and producing to continue borrowing and spending. As a result, the more money the world loans us, the less capable we are of paying it back. I really wish the world would stop doing us favors, as neither party can afford the consequences.

For a timely example, just look at California. With an unmanageable $20 billion deficit, California recently asked Washington for a bailout. With none immediately forthcoming, California was forced to make real and needed budget cuts. The hard choices, which will benefit California in the long run, would not have been made if federal funds had been committed. We all should be so lucky.

[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a well-known author and commentator, and is a periodic contributor to Money Morning. Schiff is the author of two New York Times best sellers: “Crash Proof: How to Profit from the Coming Economic Collapse,” as well as “The Little Book of Bull Moves in Bear Markets.” For a more-detailed look at our ongoing financial problems – and for some strategies that will help you protect your wealth and preserve your purchasing power before it's too late – download EuroPac’s brand-new free special report, "Peter Schiff's Five Favorite Investment Choices for the Next Five Years."

Is it a new bull market, or just a bear-market rally that’s going to separate investors from the last of their cash? For the shrewdest investors, it may not matter. A new offer from Money Morning is a two-way win for investors: Schiff’s new book – “The Little Book of Bull Moves in Bear Markets” – shows investors how to profit no matter which way the market moves, while our monthly newsletter, The Money Map Report, provides ongoing analysis of the global financial markets and some of the best profit plays you’ll find anywhere. To find out how to get both, check out our newest offer.]

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Back during the U.S. invasion of Iraq, when the U.S. government issued its now-famous deck of playing cards featuring pictures of the 52 arch villains of the Iraqi police state, Saddam Hussein’s face adorned the Ace of Spades. If the Barack Obama administration wanted to engage in a similar public relations campaign – this time with a focus on the U.S. real estate crisis – that top card should be reserved for former Federal Reserve Chairman Alan Greenspan.

In a speech before the National Association of Realtors last Tuesday, Sir Alan “the-bubble-blower” Greenspan claimed that his low-interest-rate policies in the early and middle years of this decade had no effect on mortgage rates or real estate prices. As a result, he claims no responsibility for the subprime mortgage crisis. But even current Treasury Secretary Timothy F. Geithner – who shared interest-rate-policy responsibility as governor of the New York Fed during the Greenspan regime – recently admitted that overly accommodative policy helped inflate the bubble. So what does Greenspan know that everyone else doesn’t?

Greenspan’s primary defense is that mortgage rates were a function of long-term interest rates that were simply not responding to the movement in short-term rates, which he did control. While it is true that the flow of capital from foreign creditors with excess dollars did keep long rates low despite rising short rates, this “conundrum” was not the leading factor in the housing bubble. Although rates on 30-year-fixed-rate mortgages are based on long-term bonds, by 2005 such loans had become an endangered species. The housing bubble was all about adjustable-rate mortgages (ARMs) with teaser rates of one to seven years – which are primarily based on the benchmark Fed Funds.

The rock-bottom teaser rates, permitted by the 1.0% Fed Funds rate, were the primary reason that many homebuyers were able to qualify for mortgages they couldn’t otherwise afford – which, in turn, enabled them to bid U.S. home prices up to “bubble” levels. By pushing down the cost of short-term money, the U.S. central bank enabled homebuyers to make big bets on rising real estate prices. Without the Fed’s help, few borrowers would have “qualified” for these risky mortgages and real estate prices never would have been bid up so high.

Greenspan expresses exasperation now, as he did then, that his careful nudging of interest rates higher by quarter-point increments did not translate into corresponding increases in long-term rates. Unfortunately, according to Greenspan, the markets would not cooperate with his wise guidance, and to his dismay, mortgage rates fell despite his best efforts.

As they say in Texas, that dog just won’t hunt. If the “measured pace” of his quarter-point rate hikes were too slow to produce the desired effect, why didn’t Greenspan jack up the pressure? With interest rates far below the official inflation rate for so many years during the bubble, he certainly had plenty of room to maneuver. The claim that he was unhappy with the ultimate results of his rate hikes – despite his having done nothing to adjust that policy – is ridiculous.

In addition to his colossal errors on interest-rate policy, there were many other ways Greenspan blew air into the real estate bubble. One example was what the market called the “Greenspan put.” By creating the perception in word and deed (that has since proven accurate) that the Fed would backstop any major market or economic declines, lenders became more comfortable making risky loans.

In an often-quoted 2004 speech, Greenspan went so far as to actively encourage the use of adjustable-rate mortgages and praised home-equity extractions for their role in contributing to economic growth. In fact, rather than criticizing homeowners for treating their houses like ATM machines, he often praised the innovative ways in which such homeowners were “managing” their personal balance sheets.

In short, Greenspan was as much a proponent of leverage for homeowners on Main Street as he was for bankers on Wall Street.

The bottom line is that Greenspan fathered the housing bubble and now he refuses to acknowledge kinship with his wayward child. His denial of responsibility is an act of stunning bravado, and is a testament to his ability to turn even the simplest of situations into an impenetrable tangle of theories and statistics.

“The Maestro” easily trumps the private sector jokers who now hold top dishonors in our pack of economic villains. The fact that Greenspan still has any credibility shows just how little understanding the general public – including Wall Street and the media – actually has about this crisis.

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

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

News and Related Story Links:

• Wikipedia:
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• Wall Street Pit:
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• Wikinvest:
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• Wikipedia:
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• UrbanDictionary.com:
  That Dog Just Won’t Hunt.
• Amazon.com:
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When elementary school kids want to escape the confines of their circumstances, they pretend to be pirates, princesses and Jedi knights. Now, with the relaxation of “mark to market” valuation rules announced by the accounting trade’s self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent.

The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the Financial Accounting Standards Board’s (FASB) ruling on Wall Street is a clear sign that we still have some growing up to do.

The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy.

Using the “mark to market” accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By “marking” their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. But the new accounting changes will allow the nervous owners to assign more “appropriate” (i.e. higher) values. Problem solved.

It is important to note that the FASB made its rule modifications only after both Washington and Wall Street applied intense pressure. In their heart of hearts, I can’t imagine that there are too many bean counters happy with the outcome.

The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole bunch, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.

All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason agencies such as Moody’s Corp. (MCO) and Standard & Poor’s rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow.

For example, General Motors Corp.’s (GM) 10-year bonds currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.

Some argue that the comparison is invalid because GM’s bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic.

The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his adjustable-rate mortgage (ARM) might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit.

Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.

Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen.

Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent “too big to fail” institutions – hiding their toxic assets behind rosy assumptions and phony marks.

Going from the sublime to the completely ridiculous, in a speech at the just-concluded Group 20 summit in London, President Barack Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases.

According to the president, “we must spend now as an investment for the future.” So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future.

I guess Ben Franklin had it wrong too – apparently a penny spent is a penny earned.

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

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

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For a few fleeting, horrifying moments recently, the fault lines that underlie the global economic crisis erupted into plain view. With deft and quick effort, leaders in Washington, Europe and Asia papered over the fissures and fears largely subsided.

But the shock of plain truths that resulted in violent currency movements were the latest reminder that the 21st century economic order will bear little resemblance to the world we now know.

The tremors began in Beijing, where an essay from the governor of the People’s Bank of China seemed to favor the implementation of an International Monetary Fund currency to replace the U.S. dollar as the world’s reserve. In Europe, the rotating president of the European Union, outgoing Czech Prime Minister Mirek Topolanek, characterized America’s plan to combat the widening global recession as the “road to hell.” At the same time, British Member of the European Parliament Daniel Hannan made headlines the world over with his stinging rebuke of the inflationary and debt-focused policies of the current U.K. government.

As a result of these clearly voiced frustrations, the U.S. dollar suffered a drubbing. However, U.S. Treasury Secretary Timothy F. Geithner and his ministerial counterparts in Berlin, Paris and London did their best to convince everyone that the world is pulling together as one to combat the economic crisis. The charm offensive was effective in restoring calm.

Given the size and scope of the remedies that the Obama administration is cajoling the world to adopt, it is likely that the unease will grow until many countries emerge in open revolt to America’s plans.

U.S. President Barack Obama and the majority of our leadership on both sides of the aisle are confident that the right mix of monetary and fiscal policy can restart the spending party that defined America for a generation. And as the bleary-eyed revelers wisely reach for a cup of black coffee or stumble into a rehab center, Obama is pouring grain alcohol into the punch bowl hoping to lure the walking zombies back onto the dance floor. Europe and Asia fully understand that Obama will ask them to lend the booze. And
Washington is telling us that our problems result from a lack of consumer spending.

Therefore, the solution is for government spending to pick up the slack. However, if Americans are too broke to spend, then how can our government spend for us? The only money they have is taken from us through taxation. To postpone immediate tax hikes (adding interest for good measure) Washington plans to borrow more from abroad. However, if our foreign creditors refuse to pony up, much of the money will simply be printed instead.

Printing money is merely taxation in another form. Rather than robbing citizens of their money, government robs their money of its purchasing power. Many people assume that if government provides the funds we can spend our way back to prosperity. However, it’s not money we lack but production. If the government simply prints money and doles it out, we will not be able to buy more stuff; we will simply pay higher prices. The only way to buy more is to produce more. It is production that creates purchasing power, not the printing press!

Our current predicament resulted, in part, from our efforts to maintain consumer spending at unsustainable levels – primarily by the reckless extension of consumer credit. Pushing up consumer credit to levels not supported by market realities required government subsidies and guarantees. In addition, Wall Street pitched in with securitization and credit default swaps, which created a false sense of confidence among our creditors that high-risk consumer loans could actually be repaid. However, now that all those gimmicks have blown up, the entire farce has been exposed. There is simply no way to sustain an economy based on consumer credit.

The Obama administration argues that more debt will restore growth, which will then allow the repayment of borrowed money. First, our government has never, and will never, repay anything. Second, the assumption that additional borrowing and spending will restore growth is flawed. In fact, more consumer debt and government spending will undermine our economy and restrain growth.

To solve our problems we must first come to terms with their source. That is what the voices from abroad are telling us. We borrowed and spent ourselves to the brink of bankruptcy, and now we must save and produce ourselves back to prosperity.

Of course, this simple solution is rejected by Keynesian economists, who insist that we must keep spending. The “paradox of thrift,” as they call it, holds that if we stop spending the recession will worsen. While this is true, it is hardly a paradox. As they say in the fitness game, “no pain, no gain.”

No one said this was going to be easy, but the only way to rebuild a viable economy is to let the phony one collapse. If we follow the Keynesians, the fault lines will continue to widen until our wealth, our lifestyle, our very ability to prosper is swallowed up. The calls from abroad will only get louder until we face this ugly truth.

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

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

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There is an old Wall Street adage that no one rings a bell at major market tops or market bottoms. That may be true in normal times, but as many have noticed, we are now completely through the looking glass.

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

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

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

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

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

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

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

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

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

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

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

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

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With his recent pronouncement that "credit is the lifeblood of a healthy economy," U.S. President Barack Obama reiterated what has been one of his most common themes in diagnosing our economic problem. President Obama has relied on this bedrock belief to propose policies that place the restoration of credit as the highest priority.

However, despite his seemingly earnest intentions, Obama and his economic advisors have misdiagnosed the ailment.

Savings – not credit – is the lifeblood of a healthy economy. When used improperly, credit can be like a cancer that sickens an otherwise healthy economy.

What everyone seems to have forgotten at this point is that credit isn’t created out of thin air. Even in a system in which bank reserves are leveraged many times, someone has to put savings in a bank for the bank to turn around and make a loan. As a result, the bedrock is the savings, which allows for the credit to flow. Credit extended without adequate savings inevitably leads an economy into disaster.

The primary mechanism that has injected credit where it does not belong is the massive credit card industry that has developed in the United States over the last generation. The ease with which these cards may be obtained and the degree to which Americans now rely on them for routine purchases has created a culture of credit that simply has no precedent in a healthy economy. Until this culture has been reformed, America’s fight to restore economic vitality will be a lost cause.

Recently, however, a much-discussed Wall Street Journal opinion piece by top banking analyst Meredith Whitney indicated that many Americans besides President Obama are still looking toward credit as the means of economic salvation. In her piece, Whitney wrote that:

"…Undeniably, consumers look at their unused credit balances as a "what if" reserve. "What if" my kid needs braces? "What if" my dog gets sick? "What if" I lose one of my jobs? This unused credit portion has grown to be relied on as a source of liquidity and a liquidity-management tool for many U.S. consumers. If credit is taken away from what otherwise is an able borrower, that borrower’s financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully and act collectively."

In order to keep the economy functioning, Whitney asks the credit card providers and the federal government to keep credit lines open, so that millions of Americans can keep on spending. However, while such actions would certainly keep our phony economy propped up awhile longer, it would further weaken the very foundation upon which a real economy will eventually have to be rebuilt.

Without a doubt, Americans – and all other people for that matter – benefit from having access to "rainy-day money." But Americans should be saving for a rainy day, not adopting the attitude that if it rains I’ll whip out my credit card. If Americans need to pay for a suddenly ill dog, to straighten their kid’s teeth, or to pull them through a period of unemployment, they should save some of their present earnings.

But saving money requires a reduction in spending, and that is something that modern economists – inside and outside the Obama administration – cannot abide. A drop in spending will create a sharper contraction in our economy – which is now comprised 70% of consumer spending. But this is no reason to discourage the process. The option to go into debt in the event of an emergency is no substitute for building personal savings for such events. Not only does such a strategy jeopardize the solvency of individuals or families when they are at their most vulnerable, but it deprives society of badly needed savings.

Currently, with so many financially strapped Americans looking to draw on their credit lines, the fallacy of this ’savings substitute’ is easily revealed. With lenders’ capital depleted, and falling home prices and rising unemployment putting borrowers at greater risk of default, credit is naturally harder to come by. Had only a small percentage of borrowers needed to access their credit card "rainy-day funds," there would have been no credit crisis. But with a deluge drenching so many at one time, there were simply not enough credit umbrellas to go around. Had Americans actually been saving money instead, everyone would have his own umbrella and would not now be looking to borrow someone else’s.

Most importantly, as savers bank their earnings into "rainy day funds," in addition to earning interest, those savings are available to businesses to make capital investments, produce goods and services, and provide employment. Without access to those savings, such investments cannot be made, and society is worse off as a result.

Lastly, savings can always be relied upon, whereas credit is ephemeral. Recent remarks by Chinese Premier Wen Jiabao should serve notice to all Americans that the day will soon come when the Chinese stop lending us their umbrellas. When that happens, the average American will be soaked to the bone.

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

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

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With millions of homeowners now struggling to repay money that they clearly never should have borrowed, our leaders have been righteously wagging fingers at predatory lenders who allegedly enticed innocent borrowers, and the country, into a financial snake pit.

While the mortgage industry clearly deserves a good share of the blame, unindicted co-conspirators abound. The ringleaders are still at-large and are, in fact, busy hatching a plan that would dwarf their earlier mistakes.

Contrary to the message bouncing off the marble walls of the Capitol building, most borrowers in the inflating housing bubble clearly understood the terms of their loans. Most knew that they could not afford their mortgage payments once their teaser rates expired, but enthusiastically jumped into the debt pool anyway, believing that guaranteed real estate appreciation, or a quick and profitable sale, would keep them afloat, or bail them out.

Although both lenders and borrowers were acting in their own perceived self-interest, what can we say of our economic policymakers who are expected to protect the good of all? Their actions encouraged the whole sad circus. Were it not for the excessively low interest rates provided by the U.S. Federal Reserve, the lax lending standards and moral hazards supplied by Congress courtesy of Freddie Mac (FRE), Fannie Mae (FNM), and the Federal Housing Administration (FHA), and the many real estate subsidies built into the tax code, none of these predatory loans would have been possible.

Had lenders exercised better judgment, and had borrowers avoided overly burdensome debt loads, both parties would clearly be in better financial positions today. Instead, as borrowers were demanding the credit to fuel their dreams of instant real estate riches, lenders were being ordered to accommodate them.

In past generations, homebuyers were required to save for down payments and postpone their purchases until they could actually afford conventional 30-year, fixed-rate mortgages. But in recent years, as homeownership became a matter of public policy, the government accused lenders of discrimination and urged lower standards and easier terms. With government guarantees in place, the mortgage industry was happy to both expand its revenue and promote a better society.

But by denying credit, even if doing so requires borrowers to forgo something they clearly want, lenders not only provide a valuable service to borrowers, but to society. Given the mess in which we now find ourselves, due to the bad loans made during the real estate bubble, this lesson should have been well learned.

Unfortunately, it wasn’t. And now the same dynamic is now playing out on a much larger scale.

Faced with a prospect of downgrading the American lifestyle, the U.S. government is instead borrowing trillions of dollars to artificially inflate our deflating bubble economy. The money is being used to both expand the size of government and to finance additional consumer spending. Given our financial position, this is the exact opposite of what we should be doing.

Our global creditors are now making the same mistakes made by subprime mortgage lenders. They are loaning us money that we will never be able to repay. In the process, they are enabling the largest expansion in the size of our government since the New Deal and crippling an economy already suffering from excess consumption.

Although it may sound harsh, it would be far better for everyone involved if our foreign friends simply cut us off. Since their loans are merely fueling the growth of our government and artificially pumping up consumer spending, their savings will not only be lost but their sacrifice will severely exacerbate our problems.

Just as homebuyers did earlier in this decade, the U.S. government will borrow as much money as the world is foolish enough to lend, and it will use those funds to smother the life out of our economy. At this point, government is growing like a cancer, feeding mainly off the funds it borrows from abroad. In the process, it is placing a horrific debt burden on its people, committing them to either a lifetime of crippling interest payments or run-away inflation.

There is nothing inherently wrong with foreign lending. If funding were directed toward private business to enable capital investments, the loans would not only benefit lenders, they would benefit our nation as well. The funds would fortify our industrial base and provide the necessary foundation upon which to rebuild a viable economy.

If foreign lenders were to cut us off, there would be some immediate pain, but tough love is exactly what we need right now. Forcing Americans to live within their means, particularly the U.S. government, will be just as beneficial to the long-term health of our economy as similar restraint would have been had it been exercised by mortgage lenders.

It’s too bad so few of us seem capable of making this connection, or learning anything from the mistakes of the past – even when the ink in the history books has yet to dry.

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

In the midst of an ongoing financial crisis that's eradicated trillions of dollars in shareholder wealth, the profit search facing U.S. investors is tougher than ever. The uncertainty surrounding the economic-stimulus and banking-bailout plans isn't helping.  But a new Money Morning report is a two-way win for investors: It addresses the bear-market threats these plans pose, and also spotlights some of the hard-to-find but potentially lucrative profit plays that remain. The report is free of charge, and also details ways that readers can obtain a copy of the best seller, "Crash Proof," in which Schiff details the causes of the housing bubble and financial-system collapse, and tells investors how to dodge losses from the problems that are still to come. To read our free report, and to find out more about this offer, please click here.]

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There is nearly universal agreement that the opening salvo of the Obama administration’s campaign to restore health to the financial system, delivered last week by new U.S. Treasury Secretary Timothy F. Geithner, fell with a loud and ugly thud. The most common criticism is that the announcement was short on detail.

What is abundantly clear, however, is that the new administration intends to push spending back up to pre-crash levels and to fill the entire credit void that has disappeared into the black hole of the U.S. financial system. Whether or not the prior levels of spending and lending were justified by market conditions then, or now, appears to be largely unexamined.

In the worldview of Geithner, and other like-minded economists, credit, rather than savings, is the central figure in the economic equation. Therefore, the new Treasury secretary sees anything that eases the process of lending to be an effective economic policy. With such a view in mind, the centerpiece of Geithner’s plan is the commitment of as much as $1 trillion to revive the collapsed market for securitized debt. In the run-up to the Crash of 2008, it was securitization – more than anything else – that permitted Americans to borrow more than they had ever borrowed before.

Developed primarily over the last 10 years, securitization permitted loans of all shapes and sizes to be packaged into investment-ready securities. The system worked, fueling unprecedented levels of lending in the home, auto, student, and credit-card sectors. But in the last few years, as the collateral underpinning these securities collapsed in value, the trillions of dollars of securitized debt now in circulation has become the toxic sludge at the bottom of our financial pit. Geithner is making the false assumption that cleaning up and rebuilding the securitization market is a prerequisite for a healthy economy.

Our nation’s short history with wide securitization has simply shown that the process can lead to a massive mispricing of assets and risk. By artificially rebuilding the securitization market, and committing taxpayer funds as collateral, the U.S. economy will be pushed farther and farther out on a leveraged limb, until no amount of market medicine can prevent a total economic collapse.

In truth, the only vital function provided by securitization was that it offered foreign savers a pathway to lend directly to American consumers (as a Money Morning investigative story underscored), and Wall Street executives a new asset class to over-leverage for massive profits. Our economy must dispense with these gimmicks if it hopes to pursue a meaningful recovery.

After more than a decade of unsustainable borrowing and spending, the private sector is currently attempting to restore balance through reduced consumer and mortgage credit, greater savings, and lower asset prices. With its trillions of dollars of credit injections and stimulus programs, the government hopes to allay this process by force-feeding Americans a diet of more borrowing. Government leaders feel that a restored securitization market will help. It won’t. It will just grease the skids for a quicker collapse.

Credit – securitized or not – cannot be created out of thin air. It only comes into existence though savings, which must be preceded by under-consumption. Since savings are scarce, any government guarantees toward consumer credit merely “crowd out” credit that might otherwise have been available to businesses.

During the previous decade, too much credit was extended to consumers and not enough to producers (securitization focused almost exclusively on consumer debt). The market is trying to correct this misallocation, but government policy is standing in the way. When consumers borrow and spend, society gains nothing. When producers borrow and invest, our capital stock is improved, and we all benefit from the increased productivity.

Consumers default on credit much more frequently than businesses. This is because businesses typically use loans to expand, and then have greater cash flow to repay the debt. In contrast, consumers typically borrow to consume and in the process, do not improve their ability to repay. As a result, one would expect consumer credit to be harder and more expensive to obtain. But that is currently not the case. Government guarantees have altered the playing field, so that now consumers are still being offered credit while businesses are being shown the door.

By shifting credit away from producers, fewer goods and services will be produced for consumers to buy and fewer employment opportunities provided for them to earn money with which to buy the goods.

To restore prosperity, credit (derived from real savings rather than a printing press) must flow to producers. Greater liquidity for business will lead to legitimate job creation, increased production, and rising living standards. By further encumbering the economy with burdensome regulation, and by transferring business decisions to vote-seeking politicians who will bail out the irresponsible, reward failure and punish success, the government will create a society destined for misery.

In an interview following his announcement, Treasury Secretary Geithner stated that government should replace the demand lost by the private sector. However, those with even a marginal grasp of economics know that demand is unlimited. It is the ability to spend that is not.

While Americans still want all the things they wanted years ago, they have made the rational choice that they can no longer afford to buy at the same levels they once did. Using a printing press to replace this “lost demand” will simply cause consumer prices to rise. Printed money does not create new purchasing power, but merely redistributes it from savers to borrowers. And since the plan will severely undermine the real productive capacity of our economy, there will not be much purchasing power left to redistribute!

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

In the midst of an ongoing financial crisis that's eradicated trillions of dollars in shareholder wealth, the profit search facing U.S. investors is tougher than ever. The uncertainty surrounding the economic-stimulus and banking-bailout plans isn't helping.  But a new Money Morning report is a two-way win for investors: It addresses the bear-market threats these plans pose, and also spotlights some of the hard-to-find but potentially lucrative profit plays that remain. The report is free of charge, and also details ways that readers can obtain a copy of thebest seller, "Crash Proof," in which Schiff details the causes of the housing bubble and financial-system collapse, and tells investors how to dodge losses from the problems that are still to come. To read our free report, and to find out more about this offer, please click here.]

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In a speech before the London School of Economics a week ago, U.S. Federal Reserve Chairman Ben S. Bernanke offered a perverse economic theory in his quest to gather support for never-ending Wall Street bailouts.

Said Bernanke: "This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt."

In other words, credit is the lifeblood of our economy, and the continued operation of credit providers is actually an issue of national security.

In truth, not all economies run on credit. But over the last decade, the United States became a bubble economy that needed unlimited credit to keep from collapsing. In a legitimate economy, it is not credit that fuels spending and investment, but simply income and savings. It’s too bad our Fed chairman does not understand the difference.

That American families now routinely rely on credit to make every-day purchases is a habit that needs to be broken – not encouraged. What we need in America is more restraint and less indulgence.

For example, Americans in the current economy should not go into debt to buy new cars. Given the level of debt that weighs down the typical family, Americans should defer such purchases until they have paid down existing debt, or have replenished their savings to the point where they can afford to pay cash. Until that time, Americans should continue driving their old cars. In the meantime, the untapped savings could be made available to local businesses that would use it to finance badly needed capital investments.

But such a drastic reversal in financial culture represents the kind of change that no one in the outgoing or incoming White House administrations appears willing to consider. By providing perpetual support to lenders that have bankrupted themselves through bad loans, the government merely guarantees that bad economic behavior will continue.

Credit is indeed vital to an economy, but it does not constitute an economy within itself. The important thing to remember is that credit is scarce, and is limited by the stock of savings. Obviously, savings loaned to one individual is not available to be loaned to another until it the outstanding debt is repaid. If it is never repaid, the savings are lost.

Loans to consumers not only crowd out more productive loans that might have been made to business, they have a far greater likelihood of ending in default. In addition, while business loans increase our capital stock and lead to greater productivity, loans made to consumers are merely spent, and do not create conditions that will make repayment easier.

When businesses borrow to fund capital investments, the extra cash flows that result are used to repay the loans. When individuals borrow to spend, loans can only be repaid out of reduced future consumption.

One of the reasons we are in such dire straits is that consumers have already borrowed and spent too much. Many did so based on the false belief that ever-appreciating real estate would ultimately provide the means to repay their debts and finance their lifestyles. Now that reality has finally set in, why should the spending spree continue?

The fact that our gross domestic product (GDP) – 70% of which is consumption-driven – is currently contracting should not surprise anyone. In fact, such a contraction is long overdue and the government should not do anything to interfere.

In trying to perpetuate the illusion, the government wants to revive the spending spree that has led us to this disaster. But how can such actions possibly help? How will more debt improve the economy? Wouldn’t our circumstances be vastly improved if we paid off some of our debts and replenished our savings? Wouldn’t we be in better shape if instead of buying more stuff we concentrated on producing it?

The unpleasant reality is that years of bad monetary and fiscal policy have encumbered our economy with debt and undermined our industrial capacity. The sooner we can begin to repair the damages, the sooner we can right the ship. If instead we merely administer more of the same, the ship will sink in a sea of inflation.

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

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A few weeks ago, when the U.S. Federal Reserve announced a strategy designed to bring down long-term interest and home mortgage rates through unlimited Treasury bond purchases, government debt staged a spectacular rally.

To the unschooled market observer, the spike may be difficult to understand. After all, why would the value of U.S. Treasury bonds rise while their underlying credit quality is deteriorating faster than Bernie Madoff’s social schedule? The move is actually a perfect illustration of the tried and true Wall Street strategy of “buy the rumor and sell the fact.”

If it is well known that the Fed will be a big purchaser of Treasuries, those buying now will be positioned to unload their holdings when the buying spree begins. If the Fed pays higher prices in the future, traders can earn riskless speculative profits. If the traders lever up their positions, as many are likely doing, even small profits can turn unto huge windfalls.

The downside, of course, is that all of the demand for Treasuries is artificial. Treasuries are now in the hands of speculators looking to sell, not investors looking to hold. These players are analogous to the mid-decade condo-flippers who flocked to new developments for quick profits. They did not intend to occupy their properties – only to “flip” them to future buyers. Once these properties came back on the market, condo prices collapsed, as developers were forced to compete for new sales with their former customers.

This is precisely what will happen with Treasuries. Just as the U.S. government issues mountains of new debt to finance the multi-trillion annual deficits planned by the incoming Obama Administration, speculative holders of existing debt will be offering their bonds for sale as well. In order to prevent a complete collapse in the bond prices, the Fed will be forced to significantly increase its buying.

However, since the only way the Fed can buy bonds is by printing money, the more bonds it buys, the more inflation the central bank will create. As inflation diminishes the investment value of low-yielding Treasuries, the scenario will become apparent and will kick off a downward spiral. But the more active the Fed becomes in its quest to prop up bond prices, the bigger the incentive to hit the Fed’s bid.

The result will be that all Treasuries sold will be purchased by the Fed.

But with the resulting frenzy in the Treasury market, and with inflation kicking into high gear, we can expect that demand for other debt classes that the Fed is not backstopping – such as corporate, municipal and agency debt – to fall through the floor, pushing up interest rates across the board.

In order to “save” the economy from these high rates, the Fed will then have to expand its purchases to include all forms of debt. If that happens, runaway inflation will quickly turn into hyperinflation, and our currency will be worthless and our economy left in ruins.

To avoid this nightmare scenario, the Fed should pull out of the bond market before it’s too late and let prices fall to where real buyers – those willing to hold to maturity – re-enter the market. Given how high inflation will likely be by the time this happens, my guess is that long-term Treasury yields will have to rise well into the double digits to clear the market.

The grim reality, of course, is that when the real estate bubble burst, the government was able to “bail out” private parties. However, when the bond market bubble bursts, it will be the U.S. government itself that will be in need of the mother of all bailouts. If U.S. taxpayers or foreign creditors are unwilling or unable to pony up, and if the nightmare hyperinflation scenario is to be avoided, default will be the only option. If misery really does love company, Bernie Madoff’s clients might finally find some comfort.

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

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