People in the Western world are getting poorer. It might not look like that, with high standards of living and per capita incomes (which are not, by the way, the same as a high quality of life). But there's no doubt that globalization has led to wage deflation for most Western workers, especially in manufacturing but increasingly, also in services and white collar jobs.

--Yep. It's just a much more competitive world out there. And during the credit-backed boom years (really beginning in the post-World War Two years), it meant consumers were spoiled for choice with products imported from around the globe and available at relatively cheap prices.

--But remember, the one factor that's left out of all economic calculations are what are unseen. Lower prices for consumer and manufactured goods were a tangible benefit everyone could enjoy. What was unseen was the ultimate cost of shifting production off-shore and reorienting the economy to the financial industry and residential housing. It is now being "seen" in the way a fist to the face is seen...and felt.

--The ultimate cost is that most people in Western industrialized economies are getting poorer. The deindustrialization and off-shoring orgy of the last twenty years shifted productive real assets to the developing world. It lowered real wages (adjusted for inflation) as the structure of the job market shifted towards retail, housing, and consumption and away from manufacturing and production. It also lowered savings rates as people mistook easy credit and asset price appreciation for permanent prosperity.

--This cost was not apparent in the last ten years of the boom when asset prices went to the stratosphere. People appeared to be getting richer with rising home values and stock portfolios. They may have been income poor, but they were asset rich.

--On the downside of the credit cycle, people are now finding out how phony the boom was. Most of the gain in U.S. home prices over the last ten years was simply inflation-funny money financing a mortgage boom that led to a price bubble. Now, asset values are falling. Net worth is falling too.

--According to data published yesterday by the U.S. Federal Reserve, total household net worth fell by $1.3 trillion in the first quarter of this year, from $51.7 trillion to $50.4 trillion. The scary thing is that the first quarter drop was actually an improvement on the fourth quarter number, in which net worth fell by $4.9 trillion as the stock market crashed.

--For the record, we have no idea how the Fed manages to conjure these numbers, or whether they are anything close to realistic. But let's pretend for a moment they are legitimate and examine them in just a bit greater detail. Even though these are American numbers, we think they illustrate the same basic point for most Western countries: the credit cycle has left us asset poor and debt rich.

--Let's take 2002 as a starting point. It's a bit arbitrary. But it was just after the long-term peak in stock markets and just the beginning of the commodity bull market.

--Interest rates had been lowered globally in response to 9/11. And the debt boom that led to, among other things, the American mortgage boom, was on. The U.S. mortgage boom was, of course, the origin of all the securitized and collateralized assets that have brought the global financial system to its knees.

--In 2002, total U.S. household debt was "just" $8.5 trillion. Six trillion of that was mortgage debt and $2 trillion of it was credit card debt. Over each of the next four years, U.S. households grew their debt at double-digit rates. By 2007, total household debt had grown to $12.9 trillion, $10.5 trillion of which was mortgage debt and $2.4 trillion in credit card debt.

--So if you're scoring at home, mortgage debt grew by 75% in that five-year period and credit card debt grew by 20%. Overall, household debt grew by 51% in five years, from $8.5 trillion to $12.9 trillion. And what did the economy have to show for all that debt?

--Well, probably not as much as people expected. But in 2007, it looked like a good deal. The 51% increase in debt was exceeded by a 54% increase in household net worth (from $40.4 trillion in 2002 to $62.5 trillion in 2007). That doesn't seem a lot of bang for your borrowed buck. But can you really put a price on confidence and the feeling of being better off?

--Since the peak in 2007, and since the onset of the Credit Depression, household net worth has fallen by $12.2 trillion, or 20%. Over half that fall has come from falling equity prices, where household equity holdings fell from a peak value of $16.7 trillion to their current value of $9.3 trillion. The bad news is that a second wave of foreclosures on alt-A and Option ARM mortgages probably means even lower U.S. house prices and a bigger fall in net worth.

--We're not reciting this litany of depressing news to be depressing. But it's simply not a point made often enough in the financial media or by professional politicians: this economic model of stacking on the debt to buy assets doesn't make people richer. The assets inevitably fall in value when the credit stops flowing, while the debt remains.

--That's where we are today. And that's why we think the case is getting stronger that inflation is on the horizon. It's the most likely way out of the debt, aside from actually paying it off and increasing savings. Economist Arthur Laffer agrees.

--Laffer warned that the huge growth in the U.S. adjusted monetary base is bad news for investors everywhere. It is an American policy with global repercussions. Writing in the Wall Street Journal, Laffer says that, "The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10. It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless...

--He says that, "It's difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed's actions because, frankly, we haven't ever seen anything like this in the U.S. To date what's happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5%."

--Naturally, this is horrible news. But what should investors do? Avoid bonds. Fixed-income investments get hammered with inflation. Take a look at investments that rise with inflation, like oil for example. Crude futures went over $73 in NYMEX trading on Thursday. And did you see what British Petroleum reported in its 2009 Statistical Review of World Energy?

--BP reported that for the first time in ten years, global proven oil reserves have fallen. Naturally, you don't find what you're not looking for. But this little number confirms the idea we presented in our "Long Aftershock" report. Namely, the capital spending collapse in the oil industry in 2008 is going to lead to a supply shortage in the coming years. When this fact collides with recovery in demand growth, you will see much higher oil prices.

--Alexei Miller, chairman of the Russian's energy behemoth Gazprom, said he's standing by his company's estimate that oil will soon reach $250 a barrel. "This forecast has not become reality yet," Miller told the Guardian, "given that the [credit] crisis gained momentum and exerted a powerful impact on the global energy market. But does this mean that our forecast was unrealistic? Not at all."

--The decline in proven reserves doesn't mean the world is going to run out of oil next year. But investors would want to factor it in to their stock selection in the energy sector. Companies that haven't slashed exploration budgets are more likely to find oil because...well...because they are still looking for it and growing their reserves. Companies not adding to reserves are going to sell current production at today's prices and forego higher prices from future projects.

--There are other variables, of course. You have to control costs. There's political risk, too. There's probably plenty of oil to be found in Africa. But doing business there will be another matter. And of course, what about demand? Can you really have another wave of global asset deflation without an impact on global trade and economic growth? Won't oil demand stagnate if the world is swept into more deflation?

--No one knows. That's the unsatisfying truth. We did read yesterday that Chinese fixed asset investment was up nearly 33% in the first five months of the year compared to last year. The data from China's National Bureau of Statistics gives analysts hope that China's resource-driven investment agenda is enough to pull the globe out of its doldrums, or at least keep Australia out of recession.

--It's impossible that China alone could save the world. But then, that's the reality no one wants to discuss, isn't it? What if there is no saving a generation's worth of bad investment in residential and commercial property? What if households, banks, and institutions that own trillions worth of debt-backed securities simply have to take losses? What happens then? What should investors do?

--For stocks, the next ten years are hazy. The world's balance of economic power is shifting. Yesterday, for the third day in a row...not much happened in the markets. The Dow fell 24 points - hardly worth mentioning. Gold held steady at $955. Oil rose a dollar - to $71. And the dollar itself remained about where it was - at $1.39 per euro.

It is as if everyone were waiting to see what happens next. Let's see...

We've seen the biggest stock crash in history...

..the biggest property crash in history...

..the biggest deficits in history (four times the previous record!)...

..the biggest bailouts in history (we can't even count that high)...

..the biggest bankruptcies in history...

..the auto industry and the finance industry have been largely nationalized...

..the president of the United States of America is now making financial decisions for formerly private industries...

What's left to see?

Oh yes...the depression...and hyperinflation.

And...Nows the time to protect your investments from these dreadful consequences...

"Get ready for inflation and higher interest rates," warns Art Laffer in the Wall Street Journal. Remember him? Creator of the 'Laffer Curve.'

But don't worry about inflation, adds Harvard professor Gregory Mankiw, also in the Wall Street Journal: Inflation is just what we need. "In the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative..." to force people to get rid of their money as fast as possible.

Over in the bond market, investors are finding out what a little bit of inflation - or even hints of inflation - can do. People bought US Treasuries during the panic of '08 for safety purposes. Now, they're getting what we predicted. Alas, yes, they are getting what they deserve, not what they expected. Our friend Chuck Butler points out that prices of 10-year Treasuries have come down from $110 as recently as 5 months ago to just $94 this week. How's that for safety - a 15% loss!

What they were fleeing from was the uncertainty and risk of the big wide world of investing. When Lehman Brothers went broke foreign investors took the first available plane out of India, for example. But now, our friend Ajit Dayal reports that they're coming back. We're working with him now to develop an international report on investments in the BRIC countries, with ace editors on the ground in each. As soon as the report is ready we'll give you first crack at reading it here. Because right now things are looking up on the sub-continent:

"What a month!

"The 36% surge in client portfolios after the election results in India has brought the value of the client holdings back to where they were before the Lehman bankruptcy in September 2008.

"We see this as a base for a possible assault on a new peak by June 2010.

"That is the good news.

"The bad news is that many of the lessons learned in the implosion of capital markets in the year 2008 may be forgotten. Memories are short - in fact they may not exist."

Memories? Here at The Daily Reckoning we've got all the memories you could want. We may not be able to remember what we did with our car keys, but we remember that fateful day - August 15, 1971 - when Richard Nixon 'closed the gold window.' It's been downhill ever since...

In his blog, Krugman accused Ferguson of "living in a dark age of macro-economics, in which hard-won knowledge has simply been forgotten."

The "hard-won knowledge" he referred to was Keynes' "proof" that extra government spending was indeed a plus to the economy - as long as there was not full employment. Once full employment was achieved, things changed, he said. Then, government borrowing just "crowded out" private borrowing.

The world's governments - led by the United States of America - are spending trillions to head off what they believe could be a terrible depression. Yet the theory on which they hang their reasoning is such a thin string, some of the world's leading thinkers can't seem to hold onto it. Merkel thinks the theory is wrong; Ferguson thinks it's wrong. Heck, we even think it's wrong.

Not that that proves anything. We could be wrong. But we're not spending trillions of dollars based on an idea that is the subject of hot dispute. It's a dangerous plan...

"Keynsian revolution was not a triumph of good science, but of good judgment," says the FT's headline from yesterday. Ha...that's a good one. They're right, of course. There was no science in Keynes' oeuvre. It was all guesswork. But good judgment? Not much of that either.

As for Keynes' "proof," it is defective. He argues only that when the feds borrow and spend in a recession they can't "crowd out" private borrowing without also increasing economic activity - which he takes as a gain.

Which reminds us how simpleminded economists can be. Imagine a town where people borrowed and spent too much. Faced with unemployment and a slump, the mayor borrows money to build a new town hall - thus putting "idle" resources back to work.

He doesn't "crowd out" private activity, because private citizens are hunkered down, trying to pay off their debts. They save. They lend to the mayor. Private borrowers have no better use for the money.

That is the theory of it. On the surface, it appears that the mayor's stimulus plan is a big success. Pretty soon, people are working again. Money is changing hands. The new city hall is going up.

But what has really happened? The citizens will have a new town hall. But it's a building they hadn't particularly wanted when the good times were still rolling. And now they have their share of the debt the mayor incurred to build it.

Yes, it may look as though the town is more prosperous - with people employed on the new town hall, collecting paychecks and spending money. But the prosperity is phony. Citizens got not just one thing they didn't want, but two - a new town hall and more debt. And somehow, sometime in the future...other spending plans will have to be shelved so that the town hall can be paid for!

That's what Angela Merkel was saying in her attack on the central banks. When all is said and done, 10 years from now we'll be back to where we are now.

This morning, we got a call from a reporter. "How long do you think this rally will continue," she asked. "Why do you think it won't last?"

"As to the first question, we have only an intuition...based on very few historical precedents. When you get a crash as big as we had until March...you can expect a rebound for 3-6 months after. The current rebound is now almost exactly 3 months old. By our guess it could run 3 months more...which takes it to September. But it's very dangerous. If you're playing this rally, be sure to use tight trailing stops...the next leg down could be worse than the first. Remember, after the Crash of October '29 the market rallied until the following May. Then, it went down. And it didn't bottom until 1932.

"As to the second question...why can't the rally become a real boom? The answer is very simple.

Debt is either expanding. Or it is contracting. When it gets to an extraordinary high...it tends to go down. Because it can't go up any more. That's where we are now.

Since consumer debt can't increase - and since consumer incomes are definitely not increasing...especially not in Britain and America - there is no way that a consumer economy can expand.

Since it can't expand, it must contract. You can't have a boom in a consumer economy when consumer credit, consumer incomes, and consumer spending are all going down. Forget it."