Well, what’s the purpose of a correction? It’s to destroy the illusions of the previous bubble period.

How’s this one doing?

Progress is mixed. US consumers seem to have straightened up pretty fast. After the crash, they went into therapy and rediscovered their inner squirrel. Now, according to news and anecdotal reports, they’re saving all the cash they can. Savings rates, which had been near zero, are now bouncing up towards 5%. When they aren’t stashing nuts, they are becoming more independent. Reports tell us that they are planting backyard gardens…and putting in their own power plants. (Yesterday, we came across a website for people who wanted to generate their own power.) They’re said to be cutting their own hair…and their own grass, driving less, cooking their own meals, and so forth.

They are prone to backsliding at any moment, of course. And with the feds waving the bottle under their noses every day, many are bound to fall off the wagon. But on the whole…consumers seem to be breaking free of the illusion that they can get rich by spending money.

The property bubble illusion seems to have been given a good whack too. Few are those in the United States of America or Britain who would say today, ‘houses always go up in price.’ Or that ‘you can’t lose in property.’ People know it doesn’t work like that. Many speculators and homeowners alike have lost big. They’ll remember it.

Still, while the lesson has been taught…it probably has not been thoroughly learned. Many people still look for the bottom of the property bear market. They think the bottom will come soon…and that they will be able to profit from another big move up. This is not the sort of thinking you get at the real bottom. It’s the sort of thinking you get at false bottoms on the way down. It’s the sort of illusion that needs to beaten out of people by successive waves of disappointment.

Here’s what will happen. Prices will seem to stabilize. Hopeful speculators will begin to buy property again, counting on capital gains. Then, either property prices will fall again…or go nowhere. Eventually, the illusion will disappear. People will cease looking at houses as anything more than very durable consumer items, which cost money to maintain and never reward their owners with anything more than a roof over their heads and a place to keep their collections of Playboy magazines and Cabbage Patch dolls.

But in stocks – and in economics – the illusions of the bubble era have barely been dented. Okay…stocks were involved in a major fender-bender a few months ago. Investors realized that profits weren’t guaranteed…and weren’t steady. But they knew that already. That was the lesson of the downturn in 2001-2002. What they took from that earlier experience was that even though stocks go down – and may go down sharply – if you keep your nerve you can still do quite well. We can’t remember the figures exactly, but it seems to us that if you had bought at the bottom in ’02 and held for the next 5 years you could have almost doubled your money. And if you had been lucky enough to buy Google (we advised against it…) you could have done far better.

So stock market investors know there is some risk. But they still believe that you can make money by buying the dips…even the big dips. This strategy works in a bull market. It is murder in a bear market. In a major bear market, the investor comes back into the market after a dip…only to find himself in a bigger dip later on. He does this a few times and finally realizes that he is the biggest dip of all. Then, when stocks have gotten down to their major lows – at price to earnings ratios of about 5 or 8 – he is fed up. His illusions have all died in the bear traps. He’s ready to give up on stocks altogether.

Of course, that was the infamous message of the BusinessWeek cover of August 1982, which proclaimed “The Death of Equities.” BW, speaking for the great mass of disillusioned investors, had thrown in the towel.

We are far from there now. No major journal has run an obituary of the stock market. Instead, the question is ‘how much further will this rally last?’ Some think it is already exhausted. Others think it will last forever. But everyone’s thinking about it – and it’s not the sort of thinking that happens at a real bottom. At a real bottom, people have given up thinking about stocks. The illusion that stocks always go up over the long term is replaced by a new illusion – that they never go up at all!

But is it in the economic area where the illusions are most intact. Miraculously, or perhaps just stupidly, people still have faith in the economics profession…and in the economists who steer the world’s major economies. It doesn’t seem to bother them that these are the same people who failed the critical test. When the tsunami approached in the spring of ‘07…these lookouts didn’t see it.

More on this below…

Not much to say about the markets yesterday. The Dow dropped a few points. Oil held steady at $68. The dollar gained a little on the euro. The 10-year note remained parked where it was. And gold rose almost $8 – to $934.

Our intrepid correspondent Byron King offers his two cents: “The price of gold has also pulled back, from the high $900s to about $930 or so. Silver has pulled back in tandem. I’m not concerned. I’m happy to buy gold and silver cheaper. Long term, gold and silver prices are going higher. Really, where else can they go? Lower? With the current monetary madness that’s infecting the world’s central bankers?

“Precious metals prices won’t fall very far unless governments worldwide stop spending funds they don’t have. (OK, China is spending money it DOES have. Everybody else? No way.) Will governments stop spending? Doubtful. So with excess spending, we’ll see the accompanying monetary expansion from the central banks. That’ll give us more inflation.

“And the only effective defense against inflation is gold and silver.”

The public still has faith in economists.

The whole world economy is underwater and the same economists who failed the critical test are manning the pumps. What makes anyone think they know what they are doing? On the surface of it their plan is absurd. Commerce, industry and households drown in a sea of debt; these fellows throw them a bucket of water. Asked to explain themselves, they resort to voodoo economics. “If we give Wall Street a lot of taxpayer money they will feel more like lending to households. That will bring a recovery,” they say. “And oh yes, we’ll give money to automakers who couldn’t make it on their own, too.”

The feds are spending trillions – buying up trillions worth of Wall Street’s mistakes…bailing out failed banks, insurance firms and even automobile companies…subsidizing borrowers…and realizing their own boondoggle projects.

If Ben Bernanke were a teenaged girl, his name would be written on every public bathroom wall in town.

“Where does the money come from?” we ask.

“Oh…it comes from lenders…” say the fed economists, “and if we don’t get enough from lenders, we will print up the rest. The important thing is that business has enough money to keep doing what it is doing.”

“Isn’t it losing money?”

“Well…yes…but only because people aren’t buying enough.”

“Aren’t they saving rather than buying because they saw what happened the last time you told them they didn’t need to save? “

“Well…maybe…but now they are gumming up the economy by sitting on idle capital. We need to put it to use.”

“Is that what you call paying bankers’ bonuses?”

“Look, if we don’t support the banks, they will collapse…and then the whole financial system will come down on our heads.”

“But isn’t a mismanaged bank supposed to collapse?”

As you can see as well as we can, this conversation is a waste of time. The cornerstone illusion is never even addressed. And people never even question it.

The meddlers claim that their central planning will do a better job of directing the economy than free people will do on their own. Instead of letting honest lenders and borrowers set interest rates, for example, the interveners set them – much lower than they would otherwise probably be (we don’t really know…we never get a chance to find out)… Rather than let companies fail in the open market, the feds prop them up. “They’re too big to fail,” they say. And rather than let people spend their own money according to their own preferences, the feds borrow trillions of it – on the pretext that only Treasury bonds are safe – while simultaneously undermining the value of the dollar through excess debt and excess currency creation.

The illusion is so big we scarcely see it – that an economy…even one involving more than a billion participants, speaking hundreds of different languages in more than a hundred different countries and 24 different time zones…can be successfully ‘managed’ by a group of mountebanks who missed the biggest financial event in history.

That illusion will take a long time to be crushed. It will be an entertaining show for us…

That is our purpose here at The Daily Reckoning. We point and laugh at the pretensions and illusions around us. For most people, however, the end of the Grand Illusion…that economists can direct the economy better than people can do on their own…will probably be a miserable, frustrating time.

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