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"Consumer spending slowing, but how much?" asks one headline. "House prices cooling, but not collapsing," states another.

When we parted from you yesterday, dear reader, we told you Ben Bernanke was fighting a war on two fronts. There is the war trumpeted in the headlines - against inflation. But there is another war, too, against deflation, which is much more threatening. But that is left to the footnotes.

Many people wonder why Bernanke bothers to battle inflation at all. Core inflation numbers are mostly unchanged...and still low. What isn't so low is the price of gasoline, which is now at $3.00 a gallon, according to yesterday's news. And here, the trail gets confusing. The rising price of gasoline is a sign of inflation, is it not? Yet, what it does is siphon money out of the consumer economy. Motorists from San Jose to St. Augustine take dollar bills out their pockets and pay it to the oil companies, who turn around and send it to Saudi Arabia or Russia. The foreigners add to their claims on U.S. assets, while the supply of spendable "money" in America falls.

This is the curious "flation" that the U.S. faces. American consumers are running out of money just as their most important consumer prices rise.

And so, along with Ben Bernanke, we are caught in a labyrinth of conflicting and contradictory paths. What can we do but follow the trail like Theseus' winding thread and hope it leads us out of the Minotaur's deadly labyrinth.

The first corridor we take leads us to an interesting discovery. Why would the Fed raise rates when there is no real inflation? In the recent market pullback, for example, investors dumped gold and commodities as well as emerging-market shares. They would not have done so had inflation been a worry. No, the Fed raises rates not so much to fight inflation as to fight deflation. Increasing short-term rates helps convince investors that inflation will be no problem, thus are they willing to lend long-term at lower rates. Lower long-term mortgage rates help sustain the real estate boom on which the entire economy depends.

But now we take a corridor to the left. And as we follow along, we notice the way the landscape changes. Years of booming stock prices gave way to years of booming house prices. Now, prices for both housing and stocks seem to be stuck...or actually falling. This is not inflation. This is asset price deflation. And it must be what the Fed most fears. When prices for residential housing go down...so does the U.S. economy.

Ah. So, then we turn to the right. What most economists expect now, we read, is neither typical inflation nor typical deflation. According to yesterday's newspaper reports, they look for "stagflation" to play a leading role.

Do you know how stagflation works, dear reader? If not, we are happy to supply you with an explanation. Remember how the Fed "stimulates" the economy? It does it by inflating the money supply. More money makes people think they have more wealth, leading them to make more mistakes. They borrow, they buy, they build, they spend, they invest...and whee! Oh, what a beautiful boom!

But after a while, people begin to realize that all this crisp fresh money is a fraud. Prices rise, and the consumer finds he has no more spending power than before. The businessman has expanded capacity, but finds he has no more customers than before. The investor looks at his returns, adjusts for inflation, and discovers that he has no more money than before. Once the humbug is unmasked, it no longer works. The Fed continues to introduce more "money," prices rise, but there is no boom anymore. The party is over. That, dear reader, is stagflation.

Milton Friedman predicted it in the '60s. Friedman might have been wrong about a number of things, but on this he was right. In the '70s, stagflation came to America.

And thus we remind you, dear reader, of an Essentialist Economic Principle: A slump is opposite and equal to the fraud that preceded it.

The recession of the '70s was the worst one since the Great Depression.

But in the '70s, America still has a few things going for it. It was still a major creditor, one that was able to finance its own consumption. Back then, the rest of the world owed us money, not the other way around.

American mortgages were relatively low and the typical family could still pay its bills without mortgaging the house. The U.S. government ran its last real surplus during the Nixon years. Back in the 70s, we still bought and sold from overseas at a net surplus.

But then, following our bright thread, we move on and find that since 2001, 73% of all new government borrowings have come from overseas. And the imbalance between what is sold to foreigners and what is bought from them is so great that empty containers are piling up in southern California. They come bearing goods from Asia. But America has nothing to send back. So, the empty containers pile up in storage lots - so high that the locals are complaining that they block the view. As for the rest - mortgages, debt, deficits and all - you have heard the story often enough already.

All of which suggests that Bernanke's next war will a tough one. But a war against what? Inflation? Deflation? Stagflation? Or will it be some new kind of "flation" that hasn't even been invented yet?

[Ed. Note: It looks like stagflation is about to raise its ugly head again. That's why we've assembled an emergency session of our 10 most gifted Wall Street analysts, traders and visionaries. And they want share with you their vital advice and recommendations for the remainder of the year in a revolutionary new format. Click here for all the info:

Now, the news from our friends at Whiskey & Gunpowder...

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Mike Shedlock, reporting from Illinois:

"...So roughly speaking, of the 854,000 jobs created this year, 715,000 of them were assumed. That is a staggering 83.72% assumption. Subtract useless government jobs and the figure soars above 100%..."

For the rest of this story, see the latest issue of Whiskey & Gunpowder:

Strike Three

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And more views from gay Paris...

*** Oil is still pressing up to $75 a barrel. Gold is holding over $620.

We were happy buyers of gold below $600. At $620 we are still buyers, but less happy about it. The correction is not over. The yellow metal could dip below $600 again. But who knows?

*** Asset price deflation generally brings down all prices with it. People are less eager (and less able) to spend or invest when prices are falling.

But will a slump in America bring down oil...commodities...or gold? We don't know that either, but there is reason to think that these global assets will hold up much better than local U.S. assets. While house prices in California, for example, have far outrun the ability of Californians to pay for them, there are millions of Asians who are developing a taste for oil...and the means to buy it. Likewise, General Motors might collapse as investors begin to lose heart and lose money. But new Asian automakers might find new customers and new profits. So too might new buyers in Asia, worried central banks and skittish investors hold up the price of gold - while the price of the dollar falls.

*** And bonds? Bill Gross says the bond bear market is over. Bond prices started to become soft in June of 2003. Since then, they have gently declined. Gross may be right; a slump is usually good for bonds. Yields fall as borrowers disappear. But, again, this could be a new kind of "flation." All those foreign holders of U.S. dollar bonds could decide to lighten up. Rising energy and gold prices could scare investors out of bonds. The dollar itself could give way to foreign selling. Anything could happen. And it probably will.

*** What do we know? In answer to the general rule, the more education the better, comes the anti-rule - some things are better learned on the job than in school.

A letter from a dear reader:

"I have a friend who will be studying economics at Columbia University this coming fall. I'm all for good education, but the man is going to come out of school with a debt of about $60,000. That is a lot of money to 'invest,' what are your thoughts?"

Our thoughts? So much of life is luck...chance...serendipity. If he wants to be an economist, a degree from Columbia will be a good credential. If he wants to run a business, it will probably be worthless. Most of what he learns will be palpably wrong or practically useless. But maybe he will meet someone in class with a great new business idea...or maybe he will meet his wife.

*** And another very thoughtful letter:

"I've bought and read your book. I follow your writings in Worldnet Daily with interest. If I may be so bold, I think you're not understanding a distinction that Jefferson was making.

"I'd like to share a grammar school lesson I got in the fifth or sixth grade of Catholic elementary school. Bear in mind that this was the Fifties, and the boys were taught by the Christian Brothers. These guys were tough. Many of them, if not all, were WWII or Korean war vets. And, they had answers for most tough questions. They also were pretty blunt.

And, not a lot of patience for distinctions that did not make a difference. Strangely, they took a pretty strong position on the very topic you cited.

"Jefferson wrote 'all men are created equal.' To these battle hardened vets, there was nothing 'wrong' about this assertion. Quizzically, they would say, 'All men ARE created equal. But, all men are NOT born equal.'

"They made a BIG deal out of that. You had to approach every person with an open mind. With justice for the SOBs (Swell Old Boys)! With charity for all the people who weren't born with the advantages we had. Report cards had things like 'respect the rights of others,' 'works well with others,' and my personal favorite: 'helps others reach their potential.'

"There were a lot of funny lessons all designed to help us learn what they were trying to teach. There was one activity that had envelopes with rewards and punishments in them at random - with random rewards and punishments written on the outside. Lesson: don't judge a book by its cover. Tests where all the students' grades were equal to the lowest grade in the class. Lesson: teamwork. Classes were split into sections - smart, average, stupid, and dumb - with tests graded on improvement. Lesson: Just cause you're smart doesn't guarantee you'll win. Half way through a test, the rules were changed, no sympathy. Lesson: Life throws curves.

"And we had to adapt, live with it, and grow up.

"So, there is a theoretical 'created,' like the theory of poker. And then there is the 'born,' like playing the hand your dealt.

"Hope this ramble makes some sense, and explains what I think Jefferson was trying to say. Seems obvious to me, but then I was taught by some Marines about life."

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The Daily Reckoning PRESENTS: Readers all around the blogosphere have been picking on James Kunstler this week on two counts: one, that seven years ago he took the Y2K computer scare seriously, and two, that so far, he has failed to correctly predict the end of the world. Read on...

STORMS LURKING ON THE HORIZON

by James Howard Kunstler

For those of you too young to remember, the Y2K scare was about an esoteric little programming glitch that existed almost universally in older "legacy" computer systems around the world. The glitch in essence would have prevented older systems from recognizing the date beyond 12/31/99, and this, it was widely believed, would have pranged the interdependent complex institutions and public services that ran on these computers.

There was fear that everything from municipal sewage treatment plants, to international banks, to big electric grids, to government agencies would stumble, that equipment for running these things would be badly damaged in the process, and that financial records would be lost on a broad basis.

As it turned out, very little happened on New Years Day, 2000. Scoffers exulted in their righteous rightness. The truth, though, was that immense sums of money had been spent - hundreds of billions worldwide - and countless work hours put in by programmers to avert the problem. It was a problem with a very definite deadline, and they made the deadline.

The Y2K event would have been a harsh lesson in the diminishing returns of technology and especially over-investments in complexity. Ironically, the work done, and the new equipment purchased by companies, institutions, and agencies may have played a major role in the tech boom of the late 1990s - which, of course, eventuated in the tech bust that immediately followed.

My own involvement in Y2K in the early days of blogging derived from my observation that a lot of knowledgeable tech people were taking the Y2K problem seriously, and yakking about it on the Net, and so I concluded the issue deserved attention. In retrospect, I also suppose that the one thing nobody really knew was how the programmers working on their own individual projects around the world were coming along, because a lot of that work and expenditure was going on in secret - big government agencies, big companies, and big utilities did not want to scare the public, queer their stock values, or let on about the difficulties involved in fixing the problem. And of course, the inter-connectivity of many of these complex systems - banks especially - was precisely the scariest part of the problem, meaning that it would not be okay for some of them to fix their problems and some of them to fail. As it happened, enough of them fixed their problems - at great cost - and there were no cascading failures.

Score one for advanced civilization.

Now that I have written a book titled The Long Emergency, there is a new wave of disappointment gathering - that life, as we know it has not come to an immediate end, and I am being reproached for suggesting that we have some problems. Of course, that was never the point, as a reflection on the book's title ought to suggest. One funny element of this is that the reproach reached a crescendo the very week that crude oil prices reached record levels above $75 a barrel.

So this might just be a good point to step back and ask where we are now at mid-year, 2006. In January, I predicted that the U.S. economy would get into a lot of trouble, specifically that the Dow would melt down to around 4000 and that we would see carnage on the real estate scene. When you figure in inflation, the Dow has just gone sideways for six months. What is propping it up?

Last week I referred to Doug Noland's theory that investments in alternative fuels and technology are starting a new boom. I doubt this can work as a prop to support the huge losses in previous misinvestments. For instance, sooner or later General Motors will go up in a vapor for its failure to sell cars, pure and simple.

In any case, we are faced with the essential problem of ever-increasing prices for far less net energy. That is a recipe, perhaps, for an American perestroika, but not for continuing to benefit from the old arrangements.

And so far, America at all levels, in leadership and the public, resists the sort restructuring we require. For example, we are still systematically starving and dismantling the railroad system instead of rebuilding it. There is still plenty of time left in 2006 for the stock market to start reflecting the true character of our phony-baloney economy - namely that it is based on consuming goods and resources without producing things of value.

It is my observation that the housing market is tanking broadly and steeply around the nation. In my own town, a mini "hot market," there have never been so many "for sale" signs planted in so many yards (and remaining there month after month). Some even have "price reduced" shingles added to them. But there remains mutual reinforcement between the sellers and their realtor agents to keep a happy face on the situation (to avoid panic selling).

Since house prices here, in a tourist town, are falling when the tourist season has hardly gotten underway, I have to surmise that the local market is in deep trouble. A few months from now when the tourists depart, and the last golden leaves flutter down from the maples, I expect we'll see psychological capitulation among the sellers and their realtor cheerleaders.

The energy picture, as alluded to above, is certainly cause for concern.

Oil prices are creeping up relentlessly into territory that will, at least, stall the consumption orgy among the Wal-Mart shoppers. We are one hurricane or one geopolitical incident away from an energy trauma. The natural gas supply situation is another storm lurking on the far horizon.

So, here at high noon of 2006, I'll stand pat with what I have said more than once: we have already entered the zone of The Long Emergency.

Regards,

James Howard Kunstler

for The Daily Reckoning

Editor's Note: Your editors here at Agora Financial have put their heads together for a mid-year update as well - and you get all of their forecasts and recommendations for the rest of 2006 from your own home.

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James Kunstler has worked as a reporter and feature writer for a number of newspapers, and finally as a staff writer for Rolling Stone Magazine. In 1975, he dropped out to write books on a full-time basis.

His latest nonfiction book, "The Long Emergency," describes the changes that American society faces in the 21st century. Discerning an imminent future of protracted socioeconomic crisis, Kunstler foresees the progressive dilapidation of subdivisions and strip malls, the depopulation of the American Southwest, and, amid a world at war over oil, military invasions of the West Coast; when the convulsion subsides, Americans will live in smaller places and eat locally grown food.

You can purchase your own copy here:

The Long Emergency

You can get more from James Howard Kunstler - including his artwork, information about his other novels, and his blog - at his Web site: