When stocks plummet, flee to U.S. Treasuries - bond prices go up, bond yields go down.

"But yesterday, stocks fell...and Treasury bond yields soared. Instead of selling U.S. stocks and buying American debt, traders decided to sell both. At 3.38%, the yield on a 10-year note is at its highest level since November.

"Why? Standard & Poor's served the bond market a stiff glass of reality when it threatened to strip Britain of its coveted AAA rating. Oddly still relevant, the rating agency gave the US an implicit shot across the bow...if the U.K. can lose its AAA, the U.S. can too.

"At the same time, the Federal Reserve purchased fewer Treasury securities than the market expected. During an auction yesterday, the Fed purchased 'only' $7.3 billion in US debt, or about 16% of the total debt offered. At a similar auction earlier this week, it bought upwards of 30%...not exactly the buyer of last resort.

"And nearly simultaneously, the U.S. Treasury quietly announced it will pump another $162 billion worth of U.S. debt into the market next week. Total marketable US debt will soon exceed $6.36 trillion. It's no wonder traders are finally pushing up yields... Who the hell is going to buy all this stuff?"

This could be the bond bubble popping... Or it could just be a pause in a longer trend. Whatever the case, you should be prepared for it.

Look...economies...and empires...go in cycles.

"Growth...maturity...then, decline. That's just the way it is. So in order to get an idea of what lies ahead you have to figure out where you are in the cycle.

"You never know for sure, but there are tell-tale signs. The credit cycle, for example, has been on an upswing in the US since the Great Depression. First, there was in-store consumer credit as early as the ‘20s. There was some mortgage credit...and some margin credit for investors too. But during the '30s, the financial strain was so great that most people regretted their debt and paid it down. Or they defaulted.

"You could get a mortgage back then if you put 50% down...and paid it off in full in 3 to 5 years. And then Franklin Roosevelt set up the FHA...along with Fannie Mae. And pretty soon, you could borrow 80% of the house price and pay it off over 15 years.

"Major credit cards - MasterCard and Visa - didn't become widely used until the '60s. And then, credit began to rise more steeply. Total debt had been about 150% of GDP in the '50s and '60s...but it rose quickly after the '80s. By the 2000s, you could get a mortgage for 110% of your house price - an inflated price at that. And you could take 30 years to pay it off.

"As for credit cards, hardly a day passed when you didn't get a new one in the mail...usually with a higher debt limit. Debt rose...and rose...and rose...up to 350% of GDP. And finally, the whole debt bubble blew up.

"You have to remember that the US economy - in fact, much of the whole world economy - came to rely on more and more debt as a way to expand. At first, a fellow could borrow $1.50...he'd spend it and invest it...and it would lead to an increase in GDP of $1. But, as time when by it took more and more debt to produce more GDP. The fellow would borrow a $1.50...but then, part of it would have to be used to pay the interest on what he borrowed before. Eventually, it was taking more than $6 to produce a single ounce of GDP.

"You can see that this won't work for long. GDP is like national income. You can't have debt increasing 6 times faster than income - at least not for long.

"But remember, the US economy depended on this debt-fueled growth. Without the extra credit, the economy would slip back...which is what is happening now.

"We've reached a turning point. The financial industry has blown itself up. It realized that all those credits it had, from people who didn't have the cash flow to repay their debts, weren't worth what they were supposed to be worth.

We're now on the downhill slope of the credit cycle...and most likely, the imperial cycle too.

"What everyone wants to know is how long it will take before we have a genuine recovery. And then, everyone...everyone...seems to think that the government can stir up new growth by pushing more debt onto the public...this time, public debt. And get this...the feds are now adding debt to the system at a rate four times greater than the previous record.

"They...you...are running a budget deficit of $1.8 trillion this year. Could be higher. How much in extra GDP do you get from all that extra debt? Well, that's a good question...because GDP is now going backwards. The latest numbers show output going down at a 6% rate in the US. And that's one of the world's better rates. Exporters - notably Germany and Japan - are doing much worse. GDP is falling 14% in Germany. It's going down at a 15% rate in Japan.

"So, the feds are adding trillions in new credit (debt) and getting no GDP growth from it - zero...zilch...nada. In other words debt is growing infinitely faster than GDP.

"How long can this keep going? No one knows. But one thing we do know is that the economy is not going to start up again and deliver good, old-fashioned, healthy growth. We're in the process of deleveraging. That is, we're on the downside of a credit cycle. We're getting rid of debt, not adding to it."

"Recession Turns Malls Into Ghost Towns," says the Wall Street Journal. Malls are emptying out because they were built for a world that no longer exists. They were built for a world where people increased their debt and their consumer spending far faster than they increased their real incomes. Now that people are cutting back on spending - in order to reduce their levels of debt - they can no longer afford to go to the mall. As a business or an investment, malls have got to be bad places for your money.

"The private sector is not going to take on more debt," we continued our explanation. "People know it doesn't pay. And they've got too much already. The private sector is not going to begin a new growth period until they've paid off, worked out, defaulted on, or shirked a lot of their present debt load. We've estimated that they need to get rid of about $20 trillion worth. And that's going to take time. And a lot of painful decisions by a lot of people.

Bad business, investment and spending decisions need to be recognized...and fixed. Debt needs to be reduced.

"And that's why this downturn is not going to end tomorrow."

If we'd had the mall example in front of us, we could have explained that a mall represents a kind of bubble-era investment that now needs to be restructured. After America's industrial age was over, the country found itself with empty factories and warehouses. They were mostly written off and destroyed. Some were converted - into lofts and shopping malls.

Now that the retail age is over, we'll have to find new uses for malls too.

Like snow at high altitudes, the central banks' new money is piling up. As reported last week, all the world's major central banks have turned on their snow machines. The US Federal Reserve has been authorized to "print" $1.75 trillion worth of new money in order to buy Treasury bonds. The Bank of England has its own program - worth 75 billion pounds, so far. Even Switzerland has been printing money - so much that its money supply, as measured by M2, is growing at 30% per year. And two weeks ago, the European Central Bank announced that it too would begin creating money in order to buy corporate bonds.

"Quantitative Easing" it is called. As a refresher for readers with real lives and better things to do, QE is how central banks describe what is essentially an act of counterfeiting. They buy bonds with money created - electronically - specifically for that purpose. Abracadabra - "money" comes into being.

The feds aim to provide liquidity for the cities and farms. But so far, only a trickle is coming down. Instead, chilly weather in the upper reaches of the financial sector holds it frozen in place. Hundreds of billions comes down from central banks, but there it stays...waiting for spring.

Today, here on the back page, we ask ourselves a simple question: what will happen to it?

The feds' counterfeit money does such a good imitation of the real thing, you can't tell them apart. But the problem with all money is that it is as fickle and unreliable as a bad girlfriend. One minute she goes along with the flow. The next minute she turns silly and bubbly. And then, she gives you the cold shoulder.

According to theory, an increase in the supply of something leads directly to a decrease in the price of it... That is, if other things remain constant. Despite the credit crunch, the banking freeze-up, and the economic recession, the money supply in the US as measured by M1 is actually rising at 14% per year. Yet consumer prices are not keeping pace. The latest report shows them actually going down slightly over the last 60 days.

Turns out, causing inflation is not as easy as it looked; controlling it probably will be even harder. It's not enough to manage the quantity of money; you also need to be able to control its behavior. Money can be a solid, a liquid, or a gas depending upon the temperature of the economy. At normal temperatures, money runs freely, watering the economy. And when things really get hot, it vaporizes, creating gaseous bubbles such as those of the late Bubble Period. But when the temperature falls, money shivers in wallets and bank accounts - reluctant to go out into the cold. Economists refer to the 'velocity of money" to describe the magnifying effects of motion. When the same dollar bill appears in three different places in the same day, it is as if the money supply had been multiplied three-fold. In a freeze, on the other hand, it comes to a dead stop.

When the thaw will come, we don't know. But the authorities are ready for it. When consumer prices begin to rise, they'll stop adding to the money supply. Then, they'll withdraw liquidity, as need be, to keep it under control.

They know that runaway inflation would cause problems - the collapse of the dollar...and the US Treasury bond market, for example. So, at the first signs of inflation, they will move quickly to remove excess liquidity from the system. How? Their emergency plan is simple enough. Now, they are buying bonds. When their inflation targets are met, they will begin selling them.

We thought the Bubble Epoch was the peak in claptrap and illusions. But we were only in the foothills. The feds now pretend to bail out the economy by giving money to companies that pretend to be concerned, run by people who pretend to know what they are doing. And when they run short of money, they create more of it, pretend it is real...and pretend they can tell it what to do.

What is likely is that money will have a mind of its own. First, the markets will react...and the authorities will not. They will remember their own critiques of Japanese and Roosevelt-era monetary policy. In both cases, they believe central banks removed the punch bowl too early - before the party really got rolling. In both cases, the recovery was cut off.

Then, while they are hesitating, money will turn on them. Inflation rates will rise further. The velocity of money will pick up. And investors - including foreign governments - will become eager sellers of government debt. Suddenly, it will be too late. In order to remove the monetary inflation they previously added, central banks will have to sell bonds instead of buying them, trying to re-absorb money from the economy. The extra cash would then disappear back into the central banks. But in order to bring inflation under control, the biggest bond buyers in the world must turn into the world's biggest sellers. Bond prices, already falling as investors feared the worst, will collapse immediately. An avalanche of dollars will fall upon the world markets - as dollar holders all over the world become desperate to get rid of them.

We don't know what day it will happen. But we have a good idea as to what time of day central bankers will realize that they are doomed. About 4 AM is our guess. That is the moment when Ben Bernanke and other central bankers begin to feel like members of the Donner Party. That is, like imbeciles.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning