Economic data continues to come in very soft, but the inflation meme is still strong.

Portugal got a bailout, much whining about an expected 2% fall in GDP. Hello out there, if you are running up the credit cards, you’ve got to cut back on spending. That means less consumption. I can’t imagine that 2% is anywhere near enough of a cut. I expect, for example, that consumption in the US would have to fall more than 30% to re-establish a stable economy – stable debt, adequate capital investment and sustainable growth. That’s not going to be pleasant or politically acceptable, so the can will be kicked down the road until the economy crashes. Depending on how long the can-kicking goes on, the eventual cut in living standards may well be worse than that. Basically the lack of investment is going to have to be made up sooner or later, and the later the bigger the hole that has to be filled.

At least some of the European countries are taking the bull by the horns, so to speak. The US continues to live in a Keynesian fantasy world. The Fed is monetizing government borrowings to stave off a debt crisis while it attempts to re-capitalize the banks in the traditional manner, through the interest rate spread. But the monetization is flooding the financial markets with liquidity, resulting in a run-up in most asset classes and consequently consumer price inflation, driven by commodity stockpiling. This tax on the consumer is now starting to bite, with the result that even th eillusion of growth is rapidly disappearing.

What will the Fed do? Administer more of the same medicine? – then the result will be more of the same loss of consumption and an inflationary depression. Back off? Then the result will be a deflationary depression. Fudge? Who konws, we’ll see. But there is no magic answer that doesn’t involve pain for the fat cats on the government payroll, either as employees, contractors or transfer recipients. Mohamed El-Erian says it well:

Unemployment remains stubbornly high. Youth joblessness is at alarming levels, with too many of the country’s teenagers getting close to the point where they go from being unemployed to being unemployable. Various budget constraints have limited the scope for easy solutions, even if these were desirable. The debt and deficit dynamics are bad and deteriorating at both state and federal levels. A major rating agency, Standard & Poor’s, has already taken the previously unthinkable step of placing the country’s AAA credit rating on negative outlook. And Americans can no longer rely on their central bank for yet another round of imaginative pump priming to buy them time, options and flexibility.

In effect, America can’t buy itself out of its economic problems, nor can it again kick the can down the road for much longer. Meanwhile, the rest of the world continues to outpace the U.S. in growth, competitiveness and wealth creation.

These structural problems were years in the making, and they require structural solutions that will need to be implemented steadfastly for a number of years.

History may not repeat itself, but that doesn’t mean you should ignore it either. I guess someone else has noticed the parallels between 2008 and today. To my mind, the main question is where the new financial crisis will start. My guess is Europe. And yes, I am fading the inflation hysteria.

Bernanke’s prepared remarks and Q&A on Wednesday mentioned the word “inflation” 82 times. (The word “deflation”: twice.) It is unfortunate that “inflation” was far and away the dominant theme on Wednesday, swamping “jobs,” “employment,” and “unemployment” which, in my opinion, should have been the focus.

Of course, no two business cycles or economic environments are exactly the same, but as I pointed out recently here, it is unlikely that we will enter a period of sustained high inflation absent a more taut labor market, and that, unfortunately, still seems a ways off.

Precious metals are hot hot hot as momentum chasers drive prices higher and higher, although silver got taken down a pretty good whack today. One might as well bet on a fly on the wall. As Warren Buffett said about gold: “Gold gets dug out of the ground, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Every gold bug knows that this is nonsense, poor Warren just doesn’t get it. If we just went back to the gold standard, everything would be OK, therefore gold is going to resume its role and we’ll all be rich. Forgetting for a moment that the Great Depression got started while we were on the gold standard. Also forgetting that gold currencies have been debased just like paper ones for thousands of years. But never mind, gold glitters and so long as there are speculators they will be willing to be on whether the fly will go up or down the wall. What Warren doesn’t get is that there is no point in arguing with speculative manias. They are matters of faith, not logic. He, like me, is constitutionally unable to participate. We can only look on with wonder as the trees are encouraged to grow to the sky.

It seems pretty well accepted by the markets that Greece is going to default on its debt. Yes, I know it is called “restructuring” – but the new structure is one where Greece pays less. Probably a lot less. That’s a default. The problem is that it isn’t just Greece, or even the PIIGS as a group. They are just the “subprime” sovereigns – countries that can’t pay their debts and don’t have access to a printing press to inflate the debt away. The real problem is that the moderate socialist model of government practiced in most Western countries is failing. The more extreme socialist model of government – communism – has already failed in the Soviet Union and China, while its lingering zombie states such as North Korea and Cuba provide ongoing object lessons of futility. Karl Marx, arguably the spiritual originator of these ideas, had a lot of things right. But unfortunately he was an idealist and failed to take into account the willingness to plunder the “commons.”

Let’s be clear. We’re all going to “restructure.” But it is the societies that will restructure, not just the debt. For example, just look at the US where large constituencies have staked out claims – Social Security, Medicare, government employee pensions and so forth – to a “commons” made up of money that doesn’t exist and will not exist. The sums are so large that I don’t think anyone seriously believes that they can be found. These competing claims will need to be sorted out into something that is do-able and many people will need to re-organize their lives to adjust to the reality that those payments will not be coming.

Those money claims can be related to claims on future goods and services. In order to meet them, either the supply of those goods and services will have to be substantially (and amazingly) increased, or the claims discounted to fit the available supply. The supply of goods and services can be increased by increasing employment – putting more people to work – and by increasing the productivity of those working by means of capital investment, education and training, technology and so forth. Current government policy is directly antithetical to these goals, focusing on maximizing consumption while minimizing investment.

Yes, I know things seem more or less fine as the can keeps getting kicked down the road. But as John Hussman and others have pointed out, current policy has led to a precarious and unstable position where any kind of exogenous shock has the potential to cause a catastrophic change (in the mathematical sense of the word). In implicit agreement, Bill Gross, manager of the largest bond fund in the world, has decided to stand aside from the instability by entirely divesting his portfolio of US Treasuries. Hopefully I can be a little more agile as I’m not dealing in size like Bill, who necessarily must move early and slowly because even the Treasury market is not big enough to sustain sudden moves on his part.

The next big trade, in my opinion, will be to sell stocks and commodities and buy bonds and the U.S. dollar. I’m waiting.

We know how this ends, don’t we?

This nonsense is the direct result of the Fed’s monkeying around in financial markets. Asset price increases – including, but not limited to, commodity prices – are slowly strangling the economy. Even mainstream (neoclassical, Keynesian) economists, normally completely oblivious to actual economic conditions when they differ from their forecasts, are now beginning to acknowledge the reality:

“What has it done? It has eased credit conditions, it has pumped up the stock market, it has suppressed the dollar,” said Mickey Levy, Bank of America’s chief economist. “But does the Fed think that buying Treasuries and bloating its balance sheet is really going to create permanent job increases?”

Well, in a word, yes. Because it can’t possibly be fixing the markets for the direct benefit of the wealthy asset holders who are the only beneficiaries of such a strategy? Can it? Surely no public employee would so abuse the public trust, would he?

When this bubble pops the downside will be truly brutal. Look out below as the herd runs for the exits.