What comes next

Let's take a pause from the frenzied trading (assuming you're already full on gold; if not, GLD and GDX are on sale this morning). Let's consider how this is all going to play out over the coming weeks, months, and years.

Stage 1: Paulson/Bernanke continue throwing ever greater amounts of money at the problem in increasingly radical and unprecedented ways. In addition to direct purchase of toxic waste and equities, don't be suprised to see direct government refinancing of mortgages or direct government issuance of new, low-rate mortgages to home buyers.

This may have the positive effect of downgrading The Second Great Depression to The Really Bad Recession. But it will also have the decidedly negative effect of destroying the government balance sheet.

Stage 2: As the recession deepens, job losses mount and business activity drops, cutting tax revenues and making debt service on the $11 trillion+ debt impossible. Uncle Sam becomes Casey Serin, and Treasury bonds are no-job, no-income, no-assets liar loans. The government faces two choices: default or the slow puncture of inflation. Inflation is probably the lesser of two evils, but it's no picnic, as Argentina, Zimbabwe, and Weimar Germany can attest.

How could we avoid this? Well, we could stop flushing the federal government down the toilet with the bad banks. Short of that, we could lock in today's unprecedented low Treasury rates by doing a massive 30-year auction. Once the suckers (China and OPEC) have bought at 4-5%, we could inflate our way out of this with 6-8% inflation.

A kooky substitute teacher, Mr. Dickson, once screamed, unprovoked, at an unsuspecting 6th grade class on the dangers of intraveinous drug use: "Don't you EVER stick a needle in your arm!" Likewise, I say to you today, "Don't you EVER buy a long-dated asset backed by the full faith and credit of the United States government!"

That's how I see it. What do you think?

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