Maybe we're wrong. If yesterday illustrated the essence of this market, we are definitely wrong.

Our hypothesis is that the fed's efforts to inflate will show up more in the gold market than in the stock market. That - and an instinct for self-preservation - is why we're long gold and short stocks. Stock prices depend, ultimately, on earnings. Gold's price depends, ultimately, on inflation. The feds can make more cash and credit available…but they can't wipe away all those bad debts, which are hurting earnings. That is, they can increase the rate of inflation…but not make businesses more prosperous.

We're witnessing a War of the Worlds - between inflation and deflation. We don't know which side will win, but we're betting that while inflation favors gold, deflation has it in for stocks.

But what's this? Yesterday, the Fed promised inflation - big time. It said it would pump in an extra $200 billion to fight deflation. Europe and Canada said they were in too - for another $45 billion.

Where does all this moolah come from…savings? Don't make us laugh, dear reader. It comes "out of thin air" as Keynes once said.

And what is the effect of pulling money 'out of thin air' and putting it in the money supply? More dollars…more monetary inflation.

According to our hypothesis, investors should see what's coming a mile away. They should have jumped to buy gold. Instead, they bought stocks. The Dow roared up more than 400 points. Gold barely went up $4.

So go figure. Still, oil hit a new high over $108. And sometimes it takes investors a little while to put 2 and 2 together. So, let's see what happens tomorrow before we come to a conclusion.

Besides, stocks may have gone up yesterday anyway; a rally was probably overdue. Commodities are at an all time high. Oil too. And more and more evidence comes to us that consumers are feeling squeezed…and forced to cut back on spending - which will further hurt business earnings.

"Surging cost of groceries hits home," says the Boston Globe.

"Paying at the pump, in a big way," says the New York Times. "Record fuel prices blow budgets," adds the USA TODAY.

"401(k)s tapped to save homes," it continues.

While rising prices pinch family budgets, falling asset prices pinch everyone. Most of the economy seems to be deflating. Housing is going down. Household incomes are going down. We'll have to wait a few days to find out what direction stocks are going.

The big picture still shows the same scene: America is getting poorer. Its money buys less stuff. Its working people earn less money. Its assets are worth less than they used to be.

"This thing is not about a recession or not a recession…and it's not about inflation or deflation. It's about re-pricing the U.S.A., downward. Sell America…sell its money…sell its stocks…sell its property…sell its politics…sell its economy…sell its I.O.Us. Sell it all," said a friend over the weekend. "It's clear to me that America's best days are behind it. The United States has had a disproportionate share of everything for too long - stock market valuations…the world's savings…the world's energy…the world's calories…the world's military power. That's what is changing. The world is readjusting…it's not getting out of balance; it's getting back in balance. It will be a world where the United States plays less of a role…and takes less of the world's resources."

He is probably right. Asia is growing much, much faster than the United States. Wages are going up 10% per year in China…15% per year in India. Stock markets are booming. GDP growth in many foreign countries has averaged about three times the U.S. rate for the last ten years. Now, with the U.S. economy not growing at all…Asia is racing ahead.

We have no particular quarrel with this. America has enjoyed an extraordinary run of luck. She had cheap energy…history's most powerful military…and the world's reserve currency. Now she has the world's biggest debts…its highest deficits…and the most colossal financial problem ever. In short, it has passed its I.O.Us out all over town and now owes more money to more people than anyone ever did. It now has more financial commitments any nation has ever had (with a financing gap of $60 trillion - not including the cost of the Iraq War…which is expected to be as much as $5 trillion)…and has a competitive disadvantage against much of the rest of the globe. Asians make things cheaper. Europe makes them better.

How did such nice people get themselves into such a mess? Are Americans stupider than other people? Are they lazier? More reckless…more feckless?

Nah…we're just victims of our own good fortune. We had it too good for too long. A unique set of circumstances allowed Americans to borrow and spend more than anyone ever could before…and so they did.

As an aside, this turn of events for America is where we got the idea for the title of our documentary film, I.O.U.S.A. We are hoping to have an exciting update for you, dear reader, in coming days. Stay tuned. In the meantime, check out the film's website.

*** "It's the credit bubble, stupid," says Forbes.

Yes, that is what it is…a credit bubble that is deflating. The tide is going out, as Warren Buffett puts it. Now we see who's been swimming naked. Not a pretty sight. So ugly, in fact, that people can't stand to look.

"Fed takes boldest action since the Depression," says an article in the London Telegraph.

Yes, dear reader, our leaders are doing something. Now, we just wait to find out how much damage they have done.

The hardest thing to do is nothing.

But in matters of politics and money that is usually the best thing to do.

As we've pointed out many times, nothing gets no respect. "Do something," come the cries from all corners. Even those who should know better implore public officials to take action:

"When a man is having a heart attack, you have to intervene…you can give lectures about his diet later," they say.

But the U.S. economy is not dying. It is merely adjusting to a new set of circumstances. The consumer is tapped out. Without more income he cannot increase his buying. And without more spending, the consumer economy stalls…and contracts. No, don't even think of lending the consumer more money - he has too much debt already.

This is an election year and the politicians want to dodge a contraction in the worst possible way. What would be the worst possible way? Easy - add more debt. That is precisely what the Bernanke Fed is doing. Yesterday, they offered another $200 billion to their friends in the banking industry - lent against the trashy collateral that no one else would accept. Now, the Peoples' Bank of America - ultimately, the taxpayer - will be holding the bag.

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