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It may take some time for the market to figure out what to do about it, but as always, there is no such thing as a free lunch. The American financial system is too soaked with bad debt for a government bailout to work, and the market wonвЂ™t let politicians get away with assuming all the bad debts.

Remember when Bill Clinton became outraged when he found out that вЂњa bunch of bond traders,вЂќ not politicians, determined the price of T-bonds and the interest rates that the government must charge? If investors begin to fear the governmentвЂ™s ability to pay interest and principal, they will move out of Treasuries the way they moved out of mortgages. Just as mortgage prices, rates and safety ratings were under investorsвЂ™ control, so they are for Treasuries.

governmentвЂ™s IOUs have a price, an interest rate and a safety rating. government from simply adopting all bad debts, keeping the credit bubble inflated?вЂќ Answer: The U.S. But itвЂ™s not.Д«elievers in perpetual inflation will ask, вЂњWhatвЂ™s to stop the U.S. You might think this shift of liability is a magic potion to stave off deflation. This means that the credit supply attending all these mortgages, which was in the process of collapsing, has ballooned right back up to its former level. Instead of becoming worthless wallpaper and 20-cents-on-the-dollar pieces of paper, these IOUs have, through the flap of a jaw, maintained their full, 100 percent liability. This move does not create inflation, but it is an attempt to stop deflation. Now, what exactly does that mean for deflation? This latest extension of the decades-long debt-creation scheme has essentially exchanged bad IOUs for T-bonds. One of its representatives strode to the podium to declare that it would pledge the future production of the American taxpayer in order to trade, in essence, all the bad IOUs held by speculators in Fannie and FreddieвЂ™s mortgages for gilt-edged, freshly stamped U.S. The only way to stave off deflation is for you to guarantee all the bad debts in the system.вЂќ So far, government has leapt to oblige. of credit left to lend, and we have two percentage points lower to go in interest rates. met in the back rooms of the White House in recent weekends, he must have said this: вЂњBoys, weвЂ™re nearly out of ammo. Well, the ultimate source of this seemingly risk-free credit still exists, at least for now. (Statistics courtesy of the British Treasury.) has issued them so ferociously that their value has reached 49.6 percent of annual GDP, a multiple of 250 times GermanyвЂ™s rate, and that is not in total value but only in value relative to the U.S.вЂ™s much larger GDP. Proof that these mortgages are artificial and the product of something other than a free market is the fact that while Germany, for example, has issued mortgage-backed securities with a value equal to 0.2 percent of its annual GDP, the U.S. These policies allowed borrowers to drive up house prices to absurd levels, making them unaffordable to people who wanted to buy them with actual money. As noted in the August issue, it indirectly encouraged the rest through the FedвЂ™s lending to banks and the FDICвЂ™s guarantee of bank deposits. Roughly speaking, the government directly encouraged the indebtedness of four out of five home-related borrowers. Recent reports show that these agencies, which have been stealing people blind by taking interest for nothing, account for a stunning 82 percent of all securitized mortgage debt. For investors in mortgage (in)securities, the ratio is even greater. The August issue cited our estimate that the mortgage-encouraging entities that Congress created account for 75 percent of all U.S. Congress created the Federal Reserve System and many privileged lending corporations: Fannie Mae, Freddie Mac, Ginnie Mae, Sallie Mae, the Federal Housing Administration and the Federal Home Loan Banks, to name a few.

The ultimate source of all the bad credit in the U.S. But there is one entity left that can try to stave off deflation: the federal government. Now that the downward portion of the credit cycle is firmly in force, further inflation is impossible. The following article was adapted from Robert PrechterвЂ™s NEW Deflation Survival eBook, a free 60-page compilation of PrechterвЂ™s most important teachings and warnings about deflation.

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For more on deflation and how you can survive it, download PrechterвЂ™s FREE 60-page Deflation Survival eBook, part of PrechterвЂ™s NEW Deflation Survival Guide.

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This article is part of a syndicated series about deflation from market analyst Robert Prechter, the worldвЂ™s foremost expert on and proponent of the deflationary scenario.