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As 2009 approaches and 2008 fades away, I have a few thoughts about our economy. Perhaps you can factor them into your forecasts of what lies ahead.

The people at the Federal Reserve understand the mechanics of money creation far better than the central bankers who created the German hyperinflation. The mistakes they make will be different than the mistakes of the German central bankers.

Hyperinflation would destroy the system. The Fed does not want that to happen.

Despite their intentions, the people at the Fed can destroy the system. They risk doing that now.

The Fed has a long history of over-staying its policies. It creates too much money when it is trying to revive the economy and creates too little when it is trying to slow it down. The latest example was when Greenspan gunned up money to get the economy out of the last recession. The members of the Federal Reserve Board will wait until they see a variety of prices rising before they worry about the monetary base being too high.

For quite a long time, Greenspan followed the price of gold as he conducted monetary policy. He abandoned that policy in 2001 when the economy went into recession. The Fed succumbs to political pressures.

Chairman Bernanke is an inflationist. He does not want another Great Depression, and he is willing to risk a collapse in the dollar and the system in an attempt to prevent it. There are some anti-inflationists on the Federal Reserve Board. They are in the minority. They may weakly voice some reservations, but they will go along to get along.

The Fed further weakened the backing of the dollar in 2008 by replacing Treasury securities with debts of questionable worth.

The dollar has been devalued against gold already. The market did this. By various estimates that relate gold to consumer and other prices, gold should be around $600. However, it’s now $870 or so. The price of gold is saying that there already has been a large devaluation, of the order of 50%. Prices in the economy generally rise after devaluations, although the process may take 5 years.

The Treasury and members of the government are less knowledgeable about finance than those in the Fed. They are also subject to greater political pressure. The Congress will blithely run big deficits. These will pressure the Fed to create money by buying the debt issues. The Fed has already signaled its willingness to buy this debt and buy all sorts of other debts, like consumer installment debt and mortgage paper.

The entire method of attempting to revive an economy by central bank and government manipulations is flawed. It creates a sick and weak economy based on undue credit creation and higher and higher debt burdens. This was done already from 2001 onwards and created the current economic decline.

The “natural” or unhampered and unmanipulated economy, operating freely and without government compulsion and intrusion, proceeds alongside the sick economy. Think of the Big 3 automakers, Fannie, and Freddie as examples of sickness; think of banks lending too much money to both sound and unsound borrowers to buy property.

The natural economy is what always keeps things going and produces the taxes that support the dollar and the government. It produces the goods and services we all want. The sick economy absorbs more resources than it gives back. It destroys value.

The natural economy gets stunted and suppressed when government directs resources to the sick economy through undue credit creation, to subsidies to sick companies, and to wealth transfers to people who gambled and lost.

The economy is very large. Neither the Fed nor the government can really control it. The attempt to do so weakens them and the economy both, which means it hurts us. Since this crash is so large and there is so much bad debt, at best the economy will limp along despite the massive government efforts.

The government and the Fed will be weaker than ever in terms of revenues and basic balance sheet health. But these institutions have power, with the blessing of the American people, and they are using it in large doses. They can paper over things for a while.

The extremely low yields on Treasuries are a negative sign. It shows that the economy is not producing real returns. It is stagnating. The same thing happened in the 1930s and in the Japanese economy from 1989 onwards.

The best way to have adjusted in 2008 was not chosen by our officials. That way was bankruptcy and re-organization in the economy. It would have been painful, but it would have led to a better-founded, more free, and healthier natural economy. The government—Fed way risks a breakdown of the economic and political system in a host of ways, leading to virtual dictatorship, economic controls, inflation, and slow growth.

In the past, these government-engineered revivals have not really worked. Just the opposite, as is happening now with the economy sinking into depression. FDR’s New Deal didn’t work. The Japanese government and central bank have failed to revive the Japanese economy since 1989, for almost 20 years. Their stock market (Nikkei 225) is 8,667 now. The peak in 1989 was 38,916. If the S & P 500 falls by the same percentage, it will fall from a peak of 1,562.47 to 348. It is now 904. Companies can’t make profits in these sick economies. Growth grinds to a halt.

The Japanese short-term government bonds have yielded near 0 percent for a long time. People borrow them and sell them short. They invest the proceeds in other higher-yielding government bonds, driving down their yields. This makes corporate securities look attractive, so people buy them. We then get over-investment in long-term projects that have very low returns.

Public works projects are a loser. They are low-return projects. The people working construction make money for awhile, while the rest of us lose. The actual welfare of all of the people does not improve even if the GDP holds on or grows a little. Government spending that is included in GDP doesn’t add to the well-being of most of us. The actual well-being of people is what counts, not GDP growth, not how many pyramids we build in order to keep people “working.”