Good news, bad news...and new we don’t know what the heck to make of...

The good news is that the Dow rose more than 400 points yesterday. Or, maybe that’s the bad news. This market needs a good hosing, in our opinion. Best to get it over with.

Who’s afraid of a financial meltdown? Everyone. Except us. On the other hand, we’ve never seen a financial meltdown...and maybe once we have a look, we won’t like it.

What would happen if the banks were allowed to fail? What would happen if the economy were allowed to sink into a recession quickly? What would happen if stocks were allowed to fall to 5 times earnings?

We don’t know. But we guess there would be a few major bankruptcies...a quick drop in prices...and then things would begin to rebuild on a firmer foundation. That’s what happened throughout the panics, crashes and crises of the 19th century.

Things of real value don’t disappear. The houses are still there – they’re just cheaper. So are the banks...and the insurance companies...and the automobiles...and the pizzas.

“Liquidate the banks...liquidate the farmers...liquidate labor...it will purge the rottenness out of the system...” That’s what U.S. Treasury Secretary Andrew Mellon thought in ’29, before Hoover’s world improvers put a muzzle on him. Ever since, hardly anyone has been willing to accept liquidation. They all think that if they’re smart enough they can avoid it. And the public won’t stand for it.

People don’t like losing money. We don’t like it either. But heck, that’s just the way things work. We don’t think we’re going to like old age; but it’s better than the alternative. And a meltdown, at this stage, is probably better than all the efforts made to prevent it.

That’s the trouble with free enterprise. It’s like the weather; people only like it when the sun is shining. But without the rain...things would get awful dry.

Are we making this too complicated for you, dear reader? Just kidding...but you see how simple economics is. People make mistakes. When they make mistakes there’s no point in trying to duck the consequences. The mistakes don’t go away if you deny them. The costs of them doesn’t go down if you put off paying them.

“The best way through trouble is straight through,” an old friend used to say. Let the liquidations begin!

But since the ’20s, we have a more ‘enlightened’ form of economics. John Maynard Keynes maintained that governments could manage the economy so as to eliminate the boom/bust cycle. His idea was hardly original.

Asked what the problem was in the banking system Emilio Botin, head of Santander Bank, said it was simple: “In the fat years, people made mistakes...” People always make mistakes when the going is good. They pay for them when the going isn’t so good.

Keynes’ idea was more than 2,000 years old when he thought of it; it came right out of the Old Testament story of the 7 good years and the 7 bad ones. Pharaoh knew the people wouldn’t be smart enough to save any grain for themselves. They’d make a mistake – and eat it all. So he stocked up the grain in the fat years...then, released it to the people when the lean years came. Keynes said the government should do the same -- run surpluses in the good years and deficits in the bad ones.

Since then, of course, governments have proven very good at running deficits – even in the fat years. It’s the surpluses they have trouble with. And now, the United States seems to be entering one of the leanest periods in its economic history. But when Pharaoh George II goes to the granary what does he find? It’s empty! Worse than that...he has a budget deficit of $455 billion – a record – even before the recession starts.

What the heck, he just orders bigger deficits! Cometh a report in today’s press that more and more analysts are projecting a $1 trillion US budget deficit for 2009. (We’re sticking with our $2 trillion estimate...)

But can you really run a sensible ‘Keynesian’ program without surpluses in the fat years? Can you really help your people survive a famine without stocking any grain? Can you really have the hope of Heaven without also having the threat of Hell?

We don’t know, dear reader. We doubt it. Everything seems to work in balance. Give and take. Yin and Yang. To and fro. If you don’t bother to save...you have no savings to fall back on, do you?

*** Here’s some more good news: the price of gold fell $30 yesterday. This is good news for everyone, as near as we can tell. It’s good for the world rescuers because it means investors have more faith in the dollar – and are less concerned with inflation. In fact, the latest report shows the CPI in the U.S.A. holding steady – just as you’d expect at this stage in a deflationary meltdown.

With no inflation to fear...and the threat of a widespread banking collapse averted...investors feel they have less need for gold.

This is good news for us, too, because it gives us a chance to buy the yellow metal at a lower price. At $808 an ounce, gold looks like a good deal to us . Buy gold on dips; sell stocks on rallies.

Of course, we could be wrong. We are frequently wrong. But so far...this financial crisis seems to doing what it’s supposed to do. Deflation now...inflation ahead. How far ahead? How low will gold go before it heads up again? If only we knew!

*** The bad news is that the economy continues to soften. It’s already a little like mashed potatoes. Pretty soon, it will be like potato soup.

The Philadelphia Fed, for example, has an indicator of general economic health. Yesterday’s report put it at its lowest level in 18 years. And the New York Times says house prices could continue to fall through 2009.

Houses, remember, are not an investment. They are a consumer item...a long-term consumable. They’re an expense, in other words, not a profit generator. Since they’re an expense item – like an automobile or Aunt Jemima’s pancake mix – they have to be affordable to consumers. Which is to say, the average house has to be within range of the average house buyer’s budget. By our calculation, that meant that prices would probably have to come down about 30%-40% from their 2007 peak. So far, we’re only about half way there.

*** Household incomes are falling too. Why? Last week put the fear of God in employers. They’re cutting back as fast as they can. From a conference call of business executives:

“Look, we’ve all had it pretty easy for the last few years,” explained one of the participants. “Most businesses had big profit margins. So there was no pressure to cut marginal projects or marginal employees. All that changed last week. Now we have to do what we should have done all along. Now, running a business is not easy. It’s hard.”

“I don’t know...I look at my business and wonder what all these people do,” came another opinion. “And I look at the parking lot at 5:05 PM and it’s almost empty. That tells me that my people aren’t working hard enough. I could probably get rid of half my staff and wouldn’t even notice it. My revenues would probably be the same. They might even go up.”

Not many employers like firing people. It’s like taking out the trash; you only do it when you have to. Now, profits are falling fast. Employers are getting squeezed. Their banks are no longer eager to lend. And the stock market is no longer eager to give them more capital on agreeable terms.

So, what do they do?

“Cut your ‘C players’,” was the advice.

How many “C players” are out there? Millions of them....

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