Sell stocks; buy gold.

The Dow dropped 238 points yesterday.

Gold popped up an additional 2% yesterday – taking the price to $883.

The Financial Times explains why gold rises:

“The arguments for further gains in the gold price are compelling. It looks cheap, despite climbing from a low of about $250 a troy ounce in 1999, when central banks were selling reserves. The UK’s decision back then to sell 60 per cent of its official holdings looks particularly poor judgment.

“But it is the relationship between the dollar and the reaction of the world’s central banks to the credit squeeze that some bulls would say really makes gold an attractive bet.

“The US Federal Reserve’s aggressive, rate-cutting response to the credit squeeze has created a risk of a sharp rise in American inflation. That in turn creates the risk of a precipitous fall in the dollar and so makes gold more attractive as a hedge.

“The world’s major economies have experienced rapid money supply growth of 10 per cent plus per annum in recent years. The Fed remains the world’s biggest holder of gold, yet supplies of the metal are growing at only 1.5 per cent a year. If gold is a finite currency, its value against not just the dollar, but sterling and the euro too, should rise.

“Moreover, a sharp decline in US real interest rates – financial markets expect another half percentage point cut this month – means that the low yield on gold matters less. It may have been a poor hedge against inflation in the past but the combination of rising consumer prices and economic stagnation may make it a better store of value.”

The FT goes on to say, “Gold is new global currency.”

Elsewhere in the news, the price of oil rose $2, ending a few days of downward movement. You may be tempted to see this as the triumph of the forces of inflation. But that would be far too simple. This is a battle of the Titans – inflation vs. deflation, free markets vs. government manipulators, boom vs. correction.

And guess what? We can tell you how it will end, at least in broad outline: The Titans are going to get together and destroy the U.S. economy. Inflation will reduce Americans’ purchasing power. Deflation will collapse the value of their assets. Between the anvil of falling prices and the hammer of rising ones, the American middle class is going to get smashed.

While inflation was boosting up the price of gold, deflation was playing hell with the rest of the economy.

KB, one of the largest builders, reported a loss of $773 million. And the National Association of REALTORS said it had been too optimistic previously. Remember, a few months ago the NAR said that the “worst was over” when property prices were down just 2%. And then, U.S. Treasury Secretary Paulson came out and said the subprime credit problem was “contained.” This week, both of them changed their tunes.

The NAR said housing prices were already down 5.2%. The last three months were the worst so far – with prices falling 1.7% in the quarter – the worst quarter for residential property in 21 years. And now the experts are saying that weak sales will drive down prices in the first part of 2008, with no rebound until, maybe, 2009.

Paulson now says a correction is “inevitable.” As to the problems in the credit market, he adds that there is “no easy answer.”

He must have been reading the Financial Times , which reports that a recession “has arrived” in the United States, citing a study from Merrill Lynch.

Naturally, the Fed did as expected. Rather than fight inflation, it turned its guns on deflation, cutting the signal rate by another quarter of a point, to 4.25%. The feds regard a Sushi Slump, a Japan-like recession, as the Greatest Of All Dangers. They want to avoid it in the worst possible way – by destroying the dollar . Gold, so far is just reacting, trying to keep up with declines in the U.S. currency.

But dear readers should get prepared for the next stage – when speculators turn to gold. So far, the price of the yellow metal has only returned to the nominal level it hit back in 1980. 28 years ago, it rose briefly to $850. But a lot of cash, credit, and debt and dubious financial instruments have gone under the bridge in the last quarter century. If gold had merely kept up with consumer inflation, that $850 an ounce would have had to run up to $2,200 an ounce.

So far, gold has only mirrored the decline of the dollar. The buck falls; gold rises . Since the feds are so intent on seeing the dollar go down further – in their efforts to fight the Sushi Slump – it is likely to go down much further.

But that’s not all. Pretty soon, speculators are going to start buying gold because they think it has some magic of its own. They’re going to start believing that they can get rich by owning gold, and they’re probably going to drive the price up beyond $2,000 .

So, buckle your seat belts; it’s going to be a wild ride.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.