The Dow resumed its downward slide yesterday. It lost 237 points as the deflation commandos continued their counterattack.

It’s war. And war is hell, as General Sherman said, before burning Atlanta to the ground.

Oil was unchanged in yesterday’s trading. Gold gained $5.

Most of yesterday’s hard fighting took place in the financial sector.

“Fed Sees Turmoil Persisting Deep Into Next Year,” saith the New York Times.

The New York press tells us that Steve & Barry’s, a clothing retailer with 200 stores, has filed for Chapter 11. And Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) got walloped again. The two Mississippi Companies [a reference to the government-chartered company in 18th century France that dominated a huge bubble, went broke and practically bankrupted the nation] desperately need to raise money. But even though the two are backed by the U.S. government and clearly “too big to fail,” investors are being a lot more grudging with their money these days. Fannie had to pay 74 basis points over the Treasury rate to get cash, much more than in the past. Freddie’s stock dropped to $10. Fannie’s hit $15. Both traded as high as $60, if we recall correctly.

IndyMac (NYSE:IMB) is in the news too. The big mortgage lender specialized in Alt-A loans – a step up from subprime, but apparently not a very big step. The shares traded at $50 in 2006. Yesterday, they were marked down to 44 cents.

Bloomberg tells us that Wall Street debt is being “downgraded by derivative traders.” They know the stuff better than anyone, of course.

What is surprising – to us, anyway – is that they aren’t downgrading government debt. We believe the credit cycle has turned. After a quarter century of falling yields, it looks to us as though yields have formed a major, triple-bottom. Which is to say, bond prices, (remember, they go up as yields go down) have hit three successive peaks, more or less at the same altitude, in 2003, 2005 and again in 2007.

But if we’re on the downward slope, so far it’s a gentle one. We looked yesterday and found the 10-year T-note yielding all of 3.88%.

We have to pause a minute and draw breath. What are bond buyers thinking? Of safety, surely. They see this latest assault of deflation – with falling stock prices all over the world…with Wall Street collapsing…the Fed nervously holding the key rate at 2%…oil slipping, possibly topping out – and they look for a hole to jump in. What better hole than U.S. Treasuries…dug deep by the full faith and credit of the U.S. government and denominated in the almighty dollar?

Well, ahem…that there is the problem. The hole may be deeper than they think.

Conventional wisdom holds that inflation will not be a lasting threat. The experience of the last quarter century is that short bursts of rising prices are soon replaced by another longish period of stable ones. But this was the period when the Chinese and Wal-Mart were lowering prices on manufactured goods…when labor rates were held down by the influx of millions of people into the modern economy…and before the cycle of commodity prices turned up. This was also the period in which interest rates were falling…and almost infinite amounts of money were available to increase consumer spending and production. That period is over.

Nevertheless, millions of investors expect it to continue. They believe that a cooling world economy will bring the forces of inflation back to their barracks and that they can go on collecting 3.88% coupons without feeling like chumps.

Who knows? Maybe they’re right. Still, we think they are morons. Even if they turn out to be right, the margin of safety on U.S. Treasuries is so razor thin they’re bound to cut a vein.

The real issue for us here at The Daily Reckoning is how the world ends. The world as we know it…Boomland…the world of constantly expanding credit and rising asset prices…is finished, we think. Does it end with a bang or a whimper? Does it end with the bang of inflation? Or the whimper of dying prices?

“Both” is still our best guess.

*** “People come to believe what they must believe when they must believe it,” we said today at breakfast.

“Where does that quote come from?” Elizabeth asked.

“It comes from me…from The Daily Reckoning. Many years from now, as historians search through the ruins of our civilization, someone will come across that line. Then, they’ll wonder what it meant. Finally, they’ll realize how profound it is…and probably misattribute it to some great thinker, like Thomas L. Friedman.”

“Oh stop picking on Tom Friedman…”

“Okay…but seriously, you can’t understand our era without understanding how intelligent people can come to believe such absurd things.”

“What do you mean?”

“Well, for instance, there’s a report in today’s news. The SEC did a study of the rating industry – you know, the people who decide how creditworthy various investments are. Institutional investors rely on them in placing money for pension funds and insurance and so forth. Well, they found that the rating industries engaged in what they called ‘flawed practices,’ meaning that instead of telling investors that subprime debt was trash, for example, they gave it Triple A ratings. Any dope could see that when you lend money to people who can’t pay it back you’re going to have trouble. But the rating agencies made a lot of money by rating the subprime debt. If they said it was trash, they wouldn’t get the business.

“That’s just a relatively small example. More broadly, history…and life itself…follows certain inevitable patterns. When you’re a teenager you have to think like a teenager, in other words. When you’re an old man, you have to think like an old man. If you live in Switzerland you have to think like a Swiss person. If you live in America in 2008…for good or for evil, I don’t know…but you have to think like a card-carrying member of the reigning imperial elite…that it’s your duty to police the world. If you live in an economy that is really growing and booming, you save your money and invest, in order to profit from it. But if you live in an economy that is peaking out or in decline, you just make the most of it, spending and borrowing as much as you can…and then, you gradually adjust your thinking to the new reality.”

“Yes, but how do you know thought follows action…rather than the other way around? If Americans had saved and invested…rather than borrowed and spent…wouldn’t the economy be growing, rather than declining?”

“Well, Americans would be in much better shape, financially, of course. But relative to the rest of the world, the United States would still be in decline. An old man can’t become a young man just by acting like one. All he can do is accept old age with grace and dignity.”

“You may be reaching too far with this idea…it’s a very fatalistic view of things. But why do you bring this up?”

“Oh…because I just read in the paper about poor Obama.”

“Poor Obama? I thought he was way ahead…”

“He is. But according to the report, he’s worried that he can’t attract the old Hilary stalwarts…the white, lower-middle class democrats. So, he’s modifying his views on things like Iraq, abortion and child rape. He’s coming to think what he needs to think to win the election. And what he needs to think is what appeals to the yahoo voters – the mob of electors in a late imperial period. They want to kick butt all over the world…and they want to worry about abortion and child rape, rather than bother to think about the real challenges the country faces – bankruptcy and declining living standards, for example.”

“Well, child rape and abortion are important moral issues.”

“Yes, exactly, they’re moral issues. They are the sort of thing that get a man sent to Hell. But they’re not important for the state. Whether a child rapist gets life in jail or the scaffold doesn’t matter to the health of the empire. We don’t even know which punishment is worse for the offender. But rather than bother to think about how the feds are going to close their $57 trillion dollar financing gap, or how to bring the Pentagon back under control, Obama is talking about frying child rapists. Don’t get me wrong. As far as I’m concerned the electric chair is too good for them. But these issues are like terrorism…they’re distractions, they’re bugaboos; they’re not serious challenges to a great nation. But the mob wants bread and circuses. They want Medicare, victory in Iraq…and public hangings. Obama – like every other candidate except Ron Paul – is ready to give them what they want.”

*** We have come back to Ouzilly for the summer. You editor will still be at work. He will travel to Spain, Canada, and America in the next few weeks. But he will return to rural France each time – to spend a few days of holiday.

We arrived on Tuesday night…dragging a horse van behind us. It was 10:30 at night.

“Hi, I’m Jean,” said a pleasant woman with a Midwest accent, bright red cheeks and yellow hair.

“I’m going to cook for you this summer.”

You don’t need much to be happy. But a good cook is indispensable.

Elizabeth had placed an ad on the Internet – on Craig’s List. With so many people coming and going, we need household help in the summer. Jean, from Oregon, by way of Iowa, responded. She was already in the kitchen when we arrived and had prepared a dinner for us.

“Everything is from the garden or the farm,” she announced. “The salad, the green beans, the peas, the onions, the eggs…well, not the noodles.

“It’s so nice to have a garden to work with. And Damien (the gardener) is so nice. But I think he overdoes it…”

On the floor were huge buckets overflowing with green beans, peas, onions and other vegetables we couldn’t recognize.

“I’m going to can it…or freeze it. But there’s no more room in the freezer. He overdoes it, but it’s so nice to have fresh food directly from your own garden.”

And here’s a report from USA Today: “Americans are planting gardens to cope with high food prices.”

Yes, dear reader, it doesn’t take much to be happy…or to beat rising food prices. Just begin with a good gardener …and hire a good cook.

Bill Bonner
The Daily Reckoning