“All political thinking for years past has been vitiated in the same way. People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome.”

– George Orwell

“ Hindsight is not only clearer than perception-in-the-moment but also unfair to those who actually lived through the moment.”

– Edwin S. Shneidman, Autopsy Of A Suicidal Mind

Brinkmanship is defined as the practice of pushing dangerous events to the verge of disaster in order to achieve the most advantageous outcome. It occurs in international politics, foreign policy, labor relations, and (in contemporary settings) military strategy involving the threatened use of nuclear weapons.

This maneuver of pushing a situation with the opponent to the brink succeeds by forcing the opponent to back down and make concessions. This might be achieved through diplomatic maneuvers by creating the impression that one is willing to use extreme methods rather than concede. During the Cold War, the threat of nuclear force was often used as such an escalating measure. Adolf Hitler also utilized brinkmanship conspicuously during his rise to power. (More on ignoring events and Hitler later on.)

In the last 48 hours, so much news has come out of Europe that has me frankly shaking my head. It is a strange game of brinksmanship they are playing, and it is one we should be paying attention to (as if the brinkmanship played by US politicians over the debt ceiling is not enough). This week we look at what seems to be European leaders taking random walks through the minefield at the very heart of the European Experiment. As Paul Simon wrote, “A man sees what he wants to see and disregards the rest.” But first…

Would You Like to Read Over My Shoulder?

As you know, I read scores (if not hundreds) of reports and analyses each week to put together my letters. Wouldn’t you like it if I could filter for you what is important? The few things that you should read? What would it be worth to you to have someone with my years of experience and breadth of resources available to you as your own personal reader/filter?

I can be just that. I’ve now launched a new service called Over My Shoulder to bring you the very best 5-10 pieces I read each week.

I’ll call your attention to some of the most fascinating analysts out there, people with non-intuitive perspectives on some of the most pressing issues facing us as individual investors. Concerned about inflation/deflation? Wondering about the future for US markets and sovereign debt? Europe? It’s all here.

If you need cogent analysis and clear reasoning, this is the service for you. And if you want to see the data, charts, and graphics that back it all up, you’ll get them. Would that be worth just $39 every three months? What is just one piece worth to you that helps you make that critical decision?

My job is to find you the best of the best, making sure your radar is pointed at the critical issues and weeding out all the noise. If your time matters as much as your investments, click here to learn more: http://www.johnmauldin.com/overmyshoulder/recent/

And let me hasten to note, this weekly letter will not change. It will still be free, coming to you each weekend. And now on to this week’s letter.

Last week, in the first part of my annual forecast, I suggested that 2011 would be better than Muddle Through, with GDP growth in the US north of 2.5%. World GDP growth should be even better. This week we look at what I see as the real downside risks to that prediction. Oddly enough, the risks are not in the US but on the other side of both our oceans, in Europe and China. Plus, we will visit a few other items, assuming we have space (Bernanke’s recent speech just screams for some comments).

Two housekeeping items. First, I will once again be hosting, along with my partners Altegris Investments, our 8^th annual Strategic Investment Conference, in La Jolla April 28-30. Save the date. Each year the conference gets better. We have as strong a lineup of speakers as any conference in the country. I will announce when we will take reservations. It always sells out, so I suggest you do not procrastinate.

Secondly, between finishing my book and the holidays, I have been rather quiet the past few months in regards to my Conversations with John Mauldin, but that is getting ready to change. Over the next few weeks I will be doing conversations with David Rosenberg, Lacy Hunt (his quarterly will be next week’s Outside the Box), George Friedman of Stratfor, and John Burns and Rick Sharga to get the latest on the housing markets; and I am lining up some more very interesting Conversations, so that subscribers will get more than their money’s worth. Now, let’s jump into the letter.

There are a number of economic forces in play in today's world, not all of them working in the same direction, which makes choosing policies particularly difficult. Today we finish what we started last week, the last half of the last chapter I have to write to get a rough draft of my forthcoming book, The End Game. (Right now, though, it appears this will actually be the third chapter.) We will start with a few paragraphs to help you remember where we were (or you can click here to read the first part of the chapter).

But first, I recorded two Conversations yesterday, with the CEOs of two biotech firms that are working on some of the most exciting new technologies I have come across. I found them very informative, and we will post them as soon as we get them transcribed.

For new readers, Conversations with John Mauldin is my one subscription service. While this letter will always be free, we have created a way for you to "listen in" on my conversations (or read the transcripts) with some of my friends, many of whom you will recognize and some whom you will want to know after you hear our conversations. Basically, I call one or two friends every now and then; and just as we do at dinner or at meetings, we talk about the issues of the day, back and forth, with give and take and friendly debate. I think you will find it enlightening and thought-provoking and a real contribution to your education as an investor. Plus, we throw in a series I do with Pat Cox of Breakthrough Technology Alert, where we interview some of the leading up-and-coming biotech companies; and I also do a Conversation with George Friedman of Stratfor 3-4 times a year. Quite a lot for the low price.

I recently recorded a Conversation with Mohamed El-Erian, CEO and co-CIO of PIMCO, who is one of the smartest human beings I know, as well as one of the nicest. As you can see, I can get some rather interesting people to come to the table. Current subscribers can renew for a deeply discounted $129, and we will extend that price to new subscribers as well. To learn more, go to http://www.johnmauldin.com/conversations. Click on the Subscribe button, and join me and my friends for some very interesting Conversations. (I know the price says $199 on the site, but for now you will only be charged $129 - I promise.)

All of the previous Conversations are posted and available, as well as most of the speeches from my Strategic Investment Conference a few months ago. I do work hard to make sure my subscribers get more than their money's worth. And now, to the letter.

The debate over whether we are in for inflation or deflation was alive and well at the Agora Symposium in Vancouver this this week. It seems that not everyone is ready to join the deflation-first, then-inflation camp I am currently resident in. So in this week's letter we look at some of the causes of deflation, the elements of deflation, if you will, and see if they are in ascendancy. For equity investors, this is an important question because, historically, periods of deflation have not been kind to stock markets. Let's come at this week's letter from the side, and see if we can sneak up on some answers.

Even on the road (and maybe especially on the road, as I get more free time on airplanes) I keep up with my rather large reading habit. This week, the theme in various publications was the lack of available credit for small businesses, with plenty of anecdotal evidence. This goes along with the surveys by the National Federation of Independent Businesses, which continue to show a difficult credit market.

Businesses are being forced to scramble for needed investments, generally having to make do with cash flow and working out of profits. This is an interesting quandary for government policy makers, as 75% of the "rich" that will see the Bush tax cuts go away are small businesses.

There was a great graphic (that I now cannot find) showing that all net new jobs of the past two decades have come from small businesses and start-ups. And yet as of now, when structural employment is over 10% (if you count those who were considered to be in the work force just a few months ago), we want to reduce the availability of revenues to the very people we want to be hiring new workers, and who are cash-starved as it is.

It is not just that taxes will go from 35% to just under 40%. It is the increase in Medicare taxes coming down the pike, too. We are taking money from private hands, where it has the potential to increase productivity, and putting it into government hands, where it will do nothing for growth of the economy. There is no multiplier for government spending. And tax increases reduce potential GDP by a multiplier of at least 1 and maybe 3, depending on which study you want to cite.

I understand that taxes have to go up. I get it. But we would be better off having a discussion of where we want to tax dollars to come from before we risk hurting an economy that will barely be growing at 2% in the 4^th quarter, and may be well below that. It is the increase in taxes that has me concerned about a double-dip recession.

That being said, the announcement by several prominent Democratic senators that they think we should extend the Bush tax cuts is significant. As I said a few weeks ago, we should not experience a double-dip recession absent policy mistakes. A slow-growth world, yes. But an actual double dip is rare.

If Congress were to extend the Bush tax cuts for at least a year, until the presidential commission on taxes is done with its work and THEN have the debate, it would make me far more optimistic. And it would be quite bullish for stocks, I think. Businesses would know how to plan, at least, for a year, and the economy would be given more time to actually recover. I am not ready to channel my inner Larry Kudlow, but from what we see this summer it would make me more optimistic and reduce the chances of a double-dip recession significantly.

I have been writing about The End Game for some time now. And writing a book of the same title. Consequently, I have been thinking a lot about how the credit crisis evolved into the sovereign debt crisis, and how it all ends. Today we explore a few musings I have had of late, while we look at some very interesting research. What will a world look like as a variety of nations have to deal with the end of their Debt Supercycle. We'll jump right in with no "but first's" this week.

Part of this week's writing is colored by my next conference. Next week I go to Vancouver to speak at the Agora Investment Symposium. I have a number of very good friends who will be there, both speaking and attending. This is generally a "hard money," gold-bug-type crowd (and a very large conference). Some (but not all) of the speakers believe that all fiat currencies, including the US dollar, will default in one way or another, either outright or through inflation, as mounting debts and out-of-control entitlement obligations force large-scale monetization, leading to high inflation if not hyperinflation.

There are a couple of panels and debates that I presume I will be involved in, and I have been meditating on how the panels will go. Bill Bonner, founder of Agora and a book-writing machine, has a steel-trap mind with an ability to turn a phrase that is way beyond that of your humble analyst. The preponderance of the panel members will likely be in the soft-depression camp, and most of us will card-carrying members of the Often Wrong but Seldom in Doubt school of economics and investing (the Latin for which, I am told, is "Saepe mendosus, nunquam dubius.") And yet, I am not quite there with most of that thinking, so the debates will be lively.

Understand, I started in the newsletter business back in 1981 or so, working with Dr. Gary North (also known as "Scary Gary"). Gary is an Austrian, and although I took a lot of economics courses at Rice, I had never read anything even remotely close to the Austrian school. I caught up rather quickly, and in the mid-1980s even wrote my own gold-stock newsletter (although I must admit I know next to nothing of the current gold-stock world). I was mostly limited to books, newsletters, and journals for reading material.

Then came the mid '90s and the internet, and the world opened up. I became incurably addicted to information and read widely and deeply. At some point the small lens of Austrian thought became difficult to continue to peer through, as I looked for perspectives on the larger world. I now worship at a number of economic altars, in the ongoing effort to understand what is happening in the real world, not just in the world of theory or the world of what we would like to be. So, with that background, let's look at The End Game.

"Everyone" is upset with the level of fiscal deficits being run by nearly every developed country. And with much justification. The levels of fiscal deficits are unsustainable and threaten to bring many countries to the desperate situation that Greece now finds itself in. We must balance the budget is the cry of fiscal conservatives. But there are unseen consequences in moving both too fast or too slow in the effort to get the deficits under control. Today we look at them as we explore what a fine mess we have gotten ourselves into. (I am working without internet today so the letter will be shorter with fewer references than normal.)

We have discussed the above equation before, but let's look at it again from a different angle. Basically, the equation is another accounting identity. GDP (Gross Domestic Product) for a given country is the total of Consumption (personal and business) plus Investments plus Government spending plus exports minus imports.

The Keynesians argue that when there is a drop in C due to a recession that the G must rise to offset the drop. That was at the heart of the argument for stimulus packages in so many countries. And there is no doubt that stimulus did help keep a very deep recession from turning into an even deeper depression. One can legitimately argue about the size of the stimulus, or about the nature of the spending, but it is difficult to argue that it did not have an effect.

Now, of course, the hope is that a recovery will allow C to begin to rise so that there is no more need for government deficits. Keynes argued that governments should run surpluses in good times, which is conveniently forgotten by most government spending types. The problem is that we are still running massive deficits. Tax receipts are way down (10% unemployment will do that to you!) and show no sign of turning back up soon all over the developed world.

If you reduce government spending, that also has a negative effect on GDP in the short run. But in past recoveries the growth of the private sector has overcome that negative effect. Normally at this time in a recovery growth is in the 7% range. This is a very tepid recovery in the US and the developed world.

Alice laughed. "There's no use trying," she said "One can't believe impossible things."

"I daresay you haven't had much practice," said the Queen. "When I was your age, I always did it for half-an-hour a day. Why, sometimes I've believed as many as six impossible things before breakfast."

—From Through the Looking Glass by Lewis Carroll

Economists and policy makers seem to want to believe impossible things in regards to the current debt crisis percolating throughout the world. And believing in them, they are adopting policies that will result in, well, tragedy. Today we address what passes for wisdom among the political crowd and see where we are headed, especially in Europe.

I am reminded of the great line from the movie, The Princess Bride. Vizzini is the short bad guy who is trying to get away from Westley and every thing he attempts does not work. Westley just keeps on coming. At each failed attempt, Vizzini mutters, "Inconceivable." Finally, Vizzini has just cut the rope and The Dread Pirate Roberts (Westley) is still climbing up the cliff.

Vizzini : HE DIDN'T FALL? INCONCEIVABLE.

Inigo Montoya : You keep using that word. I do not think it means what you think it means.

European leaders keep telling us that the break-up of the eurozone is inconceivable. I do not think they know what that word really means. Let's see if I can explain the problem so that even a politician can understand.

But first, and quickly. We have transcribed the speeches from my recent 7th Annual Strategic Investment Conference I put on with my US partners Altegris Investments. To say they were awesome is somewhat of an understatement. If you have registered for my free accredited investment letter, you should already have gotten a link or will get one soon to the speeches. David Rosenberg, Dr. Lacy Hunt, Paul McCulley, Niall Ferguson, Jon Sundt, Jason Cummins, Gary Shilling and your humble analyst. That is a world class line-up.

If you are an accredited investor (basically $1.5 million net worth) and have not yet signed up for my letter, then go to www.accreditedinvestor.ws and do so now. One of my partners from around the world will get in touch with you and make sure you get access to the speeches. They will also show you a world class line-up of funds and investment managers that have the potential to help your portfolio weather these tumultuous times. You really owe it to yourself to take a look. (If you are a non-US investor, there is a button on the top of the home page.) In this regard, I am a registered representative of and president of Millennium Wave Securities, LLC, member FINRA.

In a 1975 playoff game, the Dallas Cowboys were nearly out of time and facing elimination from the playoffs, down 14-10 against a very good Minnesota Vikings team. The Cowboys future Hall of Fame quarterback Roger Staubach had no very good options. He later said he dropped back to pass, closed his eyes and, as a good Catholic, said a Hail Mary and threw the ball as far as he could. Wide receiver Drew Pearson had to come back for the ball and, in a very controversial play, managed to catch the ball on his hip and stumble into the end zone. Angry Vikings fans threw trash onto the field, and one threw a whiskey bottle that knocked a referee out. After that play, all last-minute desperation passes became known as Hail Mary passes. (That was a very thrilling game to watch!)

And that is what Europe did last weekend. They threw a Hail Mary pass in an attempt to avoid the loss of the eurozone. Jean-Claude Trichet blinked. Merkel capitulated. Today we consider what the consequences of this new European-styled TARP will be for Europe and the world. We do live in interesting times.

(At the end of the letter I note that I will be speaking at the Agora Financial conference in Vancouver July 19-23. This is a wonderful conference and a lot of my good friends are speaking. They have extended their early-bird registration for one week for my readers. Join me!)

Also, I am finalizing the details on the next two Conversations with John Mauldin. The first will be on China, where I have two experts who disagree with each other. It will be fun and most enlightening. The next one will be on energy and oil. They will both be out in June.

We get a lot of positive responses to this service. Herb wrote about the last Conversation, "Wow. What a great discussion. What smart guests, how little BS. Congratulations. It's the best of your Conversations that I've listened to."

And ACK wrote: "Wow!! Just the most important discussion I have been treated to as an investor and fund manager this year or last. Your product is dreadfully underpriced, as it delivers more value and education than almost any other subscription that I have... Thanks so much... This particular conversation was just mind-blowing!"

Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the center cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

- William Butler Yeats

Last week we focused on the first half of a paper by the Bank of International Settlements, discussing what they characterized as the need for "Drastic measures ... to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability." As I noted, you don't often see the term drastic measures in a staid economic paper from the BIS. This week we will look at the conclusion of that paper, and then turn our discussion to the fallout from the problems they discuss, initially in Europe but coming soon to a country near you.

But first, what a week in the markets! I'm sure more than a few investors felt like they had a severe case of whiplash. We will discuss the volatility a little more below.

First, a very quick three-paragraph commercial. In the current market environment, there are managers who have not done well and then there are money managers who have done very well. My partners around the world would be happy to show you some of the managers they have on their platforms that we think are appropriate for the current environment. If you are an accredited investor (basically a net worth over $1.5 million) and would like to look at hedge-fund and other alternative-fund managers (such as commodity traders) I suggest you go to www.accreditedinvestor.ws and sign up; and someone from Altegris Investments in La Jolla will call you if you are a US citizen. Or you'll get a call from Absolute Return Partners in London if you are in Europe (they also work with non-accredited investors). If you are in South Africa, then someone from Plexus Asset Management will ring. And in Canada it is Nicola Wealth Management. And Fynn Capital Management in South America. (In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.)

If you are not an accredited investor, I work with CMG in Philadelphia. We have created a platform of money managers who specialize in the alternative management space. By this I mean they do not need a bull or bear market in order to have the potential for profits. (Past performance is not indicative of future results.) You can go to http://www.cmgfunds.net/public/mauldin_questionnaire.asp and quickly read about the past performance of a manager we recently added to the platform, and then sign up to get more information.

"To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown - the first instinct is to eliminate these distressing states. First principle: any explanation is better than none... The cause-creating drive is thus conditioned and excited by the feeling of fear..." Friedrich Nietzsche

"Any explanation is better than none." And the simpler, it seems in the investment game, the better. "The markets went up because oil went down," we are told, except when it went up there was another reason for the movement of the markets. We all intuitively know that things are far more complicated than that. But as Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation.

"Ah," we tell ourselves, "I know why that happened." With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brains that make us feel good. We become literally addicted to the simple explanation. The fact that what we "know" (the explanation for the unknowable) is irrelevant or even wrong is not important to the chemical release. And thus we look for reasons.

How does an event like a problem in Greece (or elsewhere) affect you, gentle reader? And I mean, affect you down where the rubber hits your road. Not some formula or theory about the velocity of money or the effect of taxes on GDP. That is the question I was posed this week. "I want to understand why you think this is so important," said a friend of Tiffani. So that is what I will attempt to answer in this week's missive, as I write a letter to my kids trying to explain the nearly inexplicable.

But first, let me note to Conversations subscribers that we have posted a Conversation I recently did with Professors Ken Rogoff and Carmen Reinhart, authors of This Time It's Different, which has my vote for most important book of the last few years.