Are markets finally heading in the right direction?

The right direction is down. It’s the way to wash out years of built-up debt that can’t be repaid and cleanse the system of bad loans,bad businesses, and bad spending.

Security was unusually heavy at the Eurostar terminal in Paris yesterday. Police roamed the halls and corridors. Long lines formed as baggage and passports were inspected. In the executive lounge, plain-clothed cops eyed packages…and studied travelers.

Then, in London…on our way to the office we passed a melee of striking cab drivers and electricians. A scuffle had broken out. A man was on the ground, surrounded by Bobbies in phosphorescent green jackets.

Europe is on edge.

“While Rome burns the eurozone fiddles” says the headline in today’s Daily Telegraph.

At least, things are starting to go in the right direction; the Dow fell 389 points yesterday.

What’s that? The right direction is down. And apart. It’s the way to wash out years of built-up debt that can’t be repaid…and cleanse the system of zombie loans, zombie businesses, and zombie spending.

The right direction is to let the accumulated wisdom of willing buyers and sellers figure out what things are worth…let them destroy those that are worthless…and raise up those that have real value.

The right direction is to let Mr. Market do it. God knows he causes enough trouble. Let him sort out the mess he makes.

But the right way is not the only way. Obviously, it’s not the way the zombies want to do it. They want to fiddle…to meddle…to manipulate the system so that the rewards go to them and the costs are put on someone else. They want to sweep problems under the carpet…and continue spending!

But yesterday, investors began to realize that there was no carpet in the world big enough to hide Europe’s government debt.

Not that the debts are particularly huge. Some are bigger than the US. Some are smaller. Generally, European governments tried to provide more and more services by going deeper and deeper into debt. Generally, the US government enticed its own households into debt — with EZ credit, low rates and government-subsided loans for students and housing. And they’re both still at it…see below…

In other words, in both Europe and America, government used centrally-planned, bureaucrat-direct zombie capital investment to make up for real growth. And you know how that goes, dear reader.

Today, again, the world’s attention is focused on Italy. “Doomed by corruption, bloated by bureaucracy and poor productivity,” says the Telegraph. But hey…it could be describing any number of places.

The unemployment rate for people between 15 and 24 in Italy is 30%. Hospitals are overcrowded. Roads have potholes. And the “country has been spending more than it earns for years….” Italy’s national debt is 120% of GDP. US debt is 100%.

But at least the Italians are civilized. They have some of the highest tax rates in Europe. They just don’t pay them.

Poor Berlusconi. He’s being forced to resign. After so many years of public service. So many years of doing his level best on behalf of the Italian people…to create a better government…a better nation…and a better world. And now they cast him out like an empty cereal box. And the popolo minuto look on…gawk…and gloat.

But at least he has a tender shoulder to cry on…and a warm smile to greet him after a hard day’s work. The Telegraph reports that the aging politician spent the night with Francesca Pascale, 26. The woman is an angel, for sure…descending from the heavens to succor the embattled Italian prime minister in his hour of need.

But let’s not get distracted by Berlusconi’s trials and tribulations. We’ve got a financial crisis on our hands. The Italian 10-year note yield jumped over 7% yesterday. It was at 7.25% when we looked this morning. At that rate, say the experts, it’s too expensive for the Italians to borrow. And if they can’t borrow, they can’t pay their bills — including about 300 billion euros-worth of debt that they’re supposed to roll over in the next 12 months.

Naturally, the holders of the debt are a bit nervous. And who holds it? Banks. That’s right. The same banks that bought housing derivatives and brought the whole world’s financial system to the brink of collapse. Now, they’ve got government debt up the kazoo. And once again, the world’s financial system edges towards a fall.

The New York Times is on the story:

Europe’s efforts to stem financial contagion foundered on Wednesday as investors dumped their holdings of Italian government bonds, prompting a global stock market sell-off.

Investors drove up the cost of borrowing for Italy beyond 7 percent, a critical level that many economists see as unsustainable and that last year precipitated bailouts for the financially troubled nations of Greece, Ireland and Portugal.

“Wednesday’s surge in Italian government bond yields has catapulted the euro zone crisis into a dangerous new phase,” said John Higgins, a senior markets economist with Capital Economics, in a research note.

Italy faces important tests of investor confidence at an auction on Thursday of one-year bills to raise 5 billion euros, and an auction next week of five-year bonds when it hopes to raise up to 3 billion euros. About 48 percent of Italian debt is held by Italian investors; the rest, 52 percent, is held by investors outside Italy, mostly in Europe.

It is unclear who beyond the central bank will be providing demand for Italian debt in the coming weeks.

Who, beyond the central bank? Our guess is that, soon or late, they will not look much further. Hold onto your gold, dear reader. Sell stocks on rallies. Buy more gold on dips.

The feds continue to lure American households into debt with subsidized mortgage rates. Bloomberg reports:

What do you think, dear reader? Do you think Ginnie Mae — inventor of the mortgage-backed derivative — has also invented a model that allows the government to have its cake and eat it too? Can the feds sell debt to American consumers…make a profit out of it…and also render a good service to the public?

Or is this just another zombie racket, run by an overpaid hack, that shifts resources to favored industries and leaves American households even deeper in debt?

Regards,

Bill Bonner
 for The Daily Reckoning