"Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces."

– Sigmund Freud

Let me introduce Mauldin's Rule of Thumb Concerning Unintended Consequences:

For every government law hurriedly passed in response to a current or recent crisis, there will be two or more unintended consequences, which will have equal or greater negative effects then the problem it was designed to fix. A corollary is that unelected institutions are at least as bad and possibly worse than elected governments. A further corollary is that laws passed to appease a particular group, whether voters or a particular industry, will have at least three unintended consequences, most of which will eventually have the opposite effect than the intended outcomes and transfer costs to innocent bystanders.

This week we wonder about the consequences of the European Central Bank (ECB) issuing over €1 trillion in short-term loans to try and postpone a banking credit crisis and lower sovereign debt costs for certain peripheral countries in Europe. What if, instead of holding the European Monetary Union (EMU or Eurozone) together, that actually makes a breakup more likely? That would certainly fall under the rubric of unintended consequences, and be worth our time to contemplate in this week's letter.

Further, what if the group that oversees credit default swaps declares an actual sovereign debt default not to be a technical default in order to avoid a credit crisis because CDSs would have to be paid? Could that actually undermine the ability of smaller countries to borrow money at lower cost, if they could even borrow it at all? Thus making the eventual outcome even worse? We will explore these perplexing questions and more as we once again turn our attention to Europe.

But first, and quickly, we are now ready to take reservations for the 9^th Annual Strategic Investment Conference, May 2-4, which this year will be in Carlsbad, California for the first time, at a venue that will allow us to take a few more attendees but still keep that intimate feeling. I host the conference, along with my partner Jon Sundt and his team at Altegris Investments.

Each year I wonder how we could make the conference any better, but I think we have done it. I must say that I do not think any conference anywhere has the quality speaking line-up that we do. It is the finest collection of top-notch raconteurs posing as economists assembled anywhere. Each speaker is a headliner in his own right, wherever they go. We have nothing but the best each year.

Look at this line-up: Dr. Woody Brock, Mohamed El-Erian, Marc Faber, Niall Ferguson, Jeff Gundlach, David Harding, Dr. Lacy Hunt, Paul McCulley, David McWilliams (from Ireland), David Rosenberg, Jon Sundt, and your humble analyst. Plus the surprise guests. Seriously, where else can you find all that talent under one roof? I design the conference each year to be the one that I would want to attend. And Sundt and team run as smooth and enjoyable a conference as you will find anywhere.

Signing up will also give you access to exclusive papers and webinars. For example, next week I'll be interviewing Winton Capital Management. For regulatory reasons, you will need to speak with Altegris to verify your accredited-investor status, prior to being allowed to attend. You can learn more and register by going to http://meetings.StrategicInvestmentConference.

I should note that the best feature of the conference is the attendees themselves. You will make new friends and meet old ones. And the speakers are very accessible. The price goes up considerably on March 15, so register early. We always sell out, and I get calls asking to get in at the last minute, and have no way to help. Don't procrastinate. Register now. We are way ahead of last year on the pace of registrations. Again, it will sell out. Do it now.

Where is the peace dividend that was supposed to come after the end of the Cold War? Where are the fruits of the amazing gains in efficiency that technology has afforded? It has been eaten by the bureaucracy that manages our every move on this earth. The voracious and insatiable monster here is called the Federal Code that calls on thousands of agencies to exercise the police power to prevent us from living free lives.

It is as Bastiat said: the real cost of the state is the prosperity we do not see, the jobs that don't exist, the technologies to which we do not have access, the businesses that do not come into existence, and the bright future that is stolen from us. The state has looted us just as surely as a robber who enters our home at night and steals all that we love.

- William "Bill" Bonner

Exactly what happened in Europe yesterday? The market reacted like it was the Second Coming of the Solution to End All Solutions. No problem here! The European debt crisis is solved! But if you look deeply (almost always dangerous when it comes to Europe) there is more to the market "melt-up" than simple euphoria and relief. What you find is a very disturbing unintended consequence that will come back to haunt us, as, sadly, I have written about in the past. The finger points to our old friends derivatives and credit default swaps. This week, as I recover from a rather nasty bug, we look at gamma and delta and other odd entities that may be behind the real reason for the market response, as we march inexorably toward the final chapters of the Endgame. Let's see how far out on a limb I can go.

But first an important announcement. I am very excited to be able to introduce my readers to a mutual fund offered by my friends at Altegris Investments. This special fund is a blend of five commodity trading advisors, or CTAs. Normally, to access a CTA you be to be an accredited investor, with all the net-worth requirements and limited liquidity. But Altegris has figured out how to wrap a mutual fund around CTAs and create a fund of commodity traders with all the usual aspects of a mutual fund (daily pricing, liquidity, etc.).

I have long been involved in the commodity-trading advisor space (some 20 years) and am a proponent of CTAs as a way to diversify portfolio risk. I have written a detailed report on this fascinating sector in relation to the fund, and it is available for free at http://www.altegrismutualfunds.com/landing/mauldinreports1.aspx, along with more information on the fund (including the offering memorandum and important risk disclosures, which are also included at the end of this letter).

The fund has been very well received since its launch and has grown rapidly to almost $1 billion. There has been very active interest in the professional community, as advisors and brokers are looking for simple and realistic ways to diversify their clients' portfolio risk in a manner that is truly noncorrelated to typical stock funds and many other asset classes. Whether you are a professional or individual, you really should take the time to research what I think is a very solid fund. My partners at Altegris have decades of experience in the CTA space, with the largest available database of CTAs and long-term relationships with many of the managers (I actually started my investment career in the commodity fund space, so I have more than a passing knowledge of the arena). Given the potential for volatility in the global markets, I think it makes sense to have some exposure to funds that can go both long and short (depending on their models). I urge you to read my report:

http://www.altegrismutualfunds.com/landing/mauldinreports1.aspx

Just as only four short years ago it was All Subprime, All the Time, and then it was the Credit Crisis, now it is Europe. (When) will Greece default and which banks will implode as a result? Is there another banking crisis in our future? I just came back from a whirlwind four-country visit to Europe, and I will try to offer a few insights. This week we start with Ireland, move to the problem of Europe at large and, if we're not out of space (and your patience!), we'll visit some last-minute data points. There is a lot to cover, so let's jump right in.

The Biggest Bubble of Them All

This week we turn from the crisis brewing in the US to the one that is coming to a slow boil in Europe. We visit our old friends Greece and Ireland and ponder how this will end. It is all well and good to kick the can down the road, but what happens when you come to the end of the road? The European answer seems to be to haul in the heavy equipment and extend the road.

I am asked all the time what my biggest worry is, and I quickly answer, the European Sovereign Debt Crisis. Of course, then we have to think about the Japanese Sovereign Debt Crisis, followed by the one in the US; but today we will focus on Europe. The biggest bubble in history is the bubble of government debt. It is a bubble in a world full of pins. It will take a great deal of luck and crisis management to keep it afloat, without wreaking havoc on the financial system and markets of the world.

The rumors have been flying all this week. Greek is going to leave the euro. No, it won’t. Germans are demanding debt restructuring, and then they say no. A German newspaper is reporting that the EU, IMF, and Germany want a Greek debt extension, while the ECB (holders of Greek debt) and France oppose it. Greek two-year bonds are now paying 25% if you care to buy them in the open market, which is effectively the market voting for some type of debt restructuring or outright default.

I sat down this week and read two lengthy reports on how Greek debt could be restructured in an orderly manner. One was from HSBC and the other from Roubini Global Economics. There are ways it can be done. But the costs of the various options may be more than the affected parties want to bear. It is not a matter of pain or no pain; it is a decision as to who will bear the pain.

When Irish eyes are smiling,
Sure, 'tis like the morn in Spring.
In the lilt of Irish laughter
You can hear the angels sing.
When Irish hearts are happy,
All the world seems bright and gay.
And when Irish eyes are smiling,
Sure, they steal your heart away.

Just when I’ve begun saying it’s safe to get back in the water, we get some shark sightings. They are a still a long ways off, but we need to keep our eyes on the deep waters and stay close to shore. This week we will look at a variety of data points and see what conclusions we can come to.

But first, I need some help from a few of you. Official publication date for my new book, Endgame: The End of the Debt Supercycle and How it Changes Everything, is March 8. I will be looking to do as much press as possible. If you are official press, drop me a note and we will get you a copy. Radio? TV? Call me.

Second, I want you to mark your calendars for April 28-30, when I will host, along with my partners at Altegris Investments, what I think will be the single best investment conference of the year. It will be the 8^th annual Strategic Investment Conference in La Jolla. Let me give you the Killer’s Row line-up of speakers, in alphabetical order: Martin Barnes (Bank Credit Analyst), Marc Faber, Niall Ferguson (author and Harvard professor), George Friedman of Stratfor, Louis-Vincent Gave of GaveKal, Neil Howe (The Fourth Turning), Paul McCulley (if he ever surfaces from his fishing vacation), David Rosenberg, Dr. Gary Shilling, Jon Sundt (of Altegris) and, of course, your humble analyst. I mean, really. Most conferences have one or two top-tier headliners. We have nothing but the best. These guys are all great speakers, but getting them on panels together? Way cool. Plus some of the best hedge-fund managers (personal opinion) show up to give you their thoughts. And maybe a surprise last-minute guest or two. If this conference lineup were a baseball team, they would sweep the World Series. Oh, and the best part? Your fellow conference attendees. The interaction among them is what truly makes this conference the best.

We (well actually, Altegris) will soon start sending out invitations, but you can register today at https://hedge-fund-conference.com/2011/invitation.aspx?ref=mauldin. Sadly, the conference is limited to accredited investors with a net worth of more than $2 million, as there are funds presenting that require that minimum (and some even more). Those are the rules we have to live with, whether I like them nor not (I don’t, as long-time readers know). But we follow them religiously.

Every year the conference sells out. Every year some of you wait to the last minute, thinking we can “always take one more.” We can’t. There is a limit to the space. If you have attended in the past, call your Altegris representative and make sure you get on the list. Do not procrastinate.

Now more than ever you need to consider the place for alternative investing in your portfolio. I work with partners around the world for both accredited and non-accredited investors. If you would like to know more, then go to www.johnmauldin.com and click on The Mauldin Circle, register there, and someone will call you. Seriously, the teams at Altegris (for US accredited investors), CMG (for those with net worth less than $2 million in the US), ARP (Europe), and others have some very innovative and interesting funds and managers on their platforms that really deserve a look. Even if you can’t make the conference, your portfolio will thank you for finding some alternative investments that make sense in these times. Now, to the letter. (In this regard, I am president of and a registered representative of Millennium Wave Securities, LLC, member FINRA.)

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.

How often did we as young kids go down the street kicking a can? “Kicking the can down the road” is a universally understood metaphor that has come to mean not dealing with the problem but putting a band-aid on it, knowing we will have to deal with something maybe even worse in the future.

Why is it that the Irish must take upon themselves the debts of their banks, which in reality are debts owed to German and French banks? Why should the Germans bail out the Greeks and the Spanish? Is the spread of “contagion” starting to taint the debt of Italy and even Belgium, the home of the EU? This week we look over the pond (of the Atlantic) and wonder how all these things will end. As I noted last week, we are getting a string of not so bad news out of the US, so now there are really just two things in the short term to worry about (at least in terms of a positive US GDP): will Congress extend the Bush tax cuts and will Europe sort itself out?

While I am on a cruise ship off the coast of Mexico (with a sporadic and very slow internet connection), the news we do get seems to suggest that the former will get done, but the latter looks rather dodgy. This week we look at a few statistics and then I try and give my US readers some perspective on Europe, by comparing Texas to Ireland (or Portugal or…). There is a connection, or at least I will try and make one. It should be fun, if a little controversial.

But first, and quickly, my friends from GaveKal will be in Dallas this week, on Wednesday December 8, for a full-day conference. If you are an accredited investor or a fund manager join me, Charles and Louis Gave (and some of their team), and George Friedman of Stratfor for a full day of presentations and analysis of the current world. Just drop me a reply and someone from either my staff or theirs will be in touch with you.

China’s currency is rising ever so slowly against the dollar. But is that hurting China? We will look at a very interesting chart and some research. And then we’ll gain some more insight into why the employment numbers seemed to surprise. I guess if you lower the bar, it’s easier to jump over. I also deal with the pushback from last week’s Outside the Box! And Ireland is on my radar. There is a lot to cover, so let’s jump in.

I start this week’s letter on a flight from Cleveland (where I was at the Cleveland Clinic meeting with my good friend and doctor Mike Roizen (of Oprah and the various “YOU” books with Mehmet Oz) on some non-health-related business, and we talked last night about the state of health care. Mike keeps pointing out that much of our health-care cost comes from chronic diseases that are either directly or partially lifestyle choices. And he is right. The data shows it. Smoking, overeating, lack of exercise – all contribute to our health-care bills. And health care was on my mind.

Now, a little mea culpa. I get letters from readers who start their missive out with something like, “I know you probably won’t read this, but…” Well, I can’t say I read every letter, but someone does and I get and read as many as I can. And my rule is that I get all the negative ones, and any letters that show particular thoughtfulness and give me suggested reading or just good suggestions. I do pay attention to you. It takes some time, I admit, but I think it is important.

And the feedback I got on last week’s Outside the Box on health care was definitely running much more on the negative side. And as it turns out, for good reason. There were just simply some factual errors in the piece that made it more partisan than it sounded when I first read it. And many readers justifiably took me to task for that.

What attracted me to the piece to begin with was the central fact that the incentives within the health-care bill give businesses significant monetary reasons to do things that are not in what I think of as the best interests of the economy or labor. Businesses will be able to save a great deal of money by canceling their employer-paid insurance plans and simply paying the fine and offering their employees some kind of cash payment to buy managed-care programs. Go to Friday’s USA Today. Read the story on Medicare-managed health care, about the shortage of specialty doctors and the denial of benefits that I think of as routine in my more or less plain-vanilla health insurance plan. I don’t think people are going to be happy.

Second, there is the incentive to hire part-time employees over full-time, and thereby not have to provide insurance. This is already an issue I see every week with my own kids, as getting full-time jobs even in relatively OK Texas is an issue. As a nation, we are already witnessing a disconcerting and still-rising level of part-time employment. Do we really want to encourage more of that?

If there is one thing we know in economics (and there are admittedly distressingly few of them), it is that people respond to incentives, whether intended or unintended. I don’t think the writers of the health-care bill intended to increase part-time employees, keep payrolls under 50 employees, or encourage businesses to dump their health insurance or move to outsourcing, etc. But if you are a business person facing budget and sales shortfalls, rising prices, and fierce competition (is there any other kind?), saving $2-3,000 per employee is going to be tempting. When two part-time employees cost $3-6000 a year less than one full-time? What do you choose when the boss is breathing down your neck about expenses? The recent employment data tells me that already businesses are opting for more part-time workers. It doesn’t work for every business, but it will for a lot of them. I hope that is not going to be the case, but I want policies that encourage and reward good corporate behavior.

For many people who read the letter, the factual errors obscured the main points. Frankly, I understand. I often have that reaction in reading other material myself. But Outside the Box is not “other material.” I put this out there, and with the core standards we have in place, I should not have been as tone deaf. I WILL be better. And in a few weeks, we will have a new website with reader forums and feedback (targeting December – this is a major project and they always take more time than I would like).

Two things I did take away from the feedback. First, most of my readers are amazingly civil in an era where simple civility on the internet is not the norm. And second, this is an extremely emotional issue. Most of us have stories about people who have been hurt by not having access to health care. And it is a lot more complex, with more moving parts, than any issue we face as a nation.

I spent some time with Newt Gingrich this Wednesday. He seems to me surprisingly upbeat about the potential for solutions to the health-care issue. He points out that there are some amazing medical advances just around the corner. A cure for Alzheimer’s would save, according to Newt, about $20 trillion over the coming decades. Cancer? Heart disease? My friend Pat Cox suggests we are on the edge of a tsunami of medical breakthroughs.

But we have been seemingly on the edge for a long time. As I wrote a few weeks ago:

Let's look down the road. I think we will at best be in a Muddle Through Economy for the next two years. Unemployment is going to be above 8%, best-case, in 2012. If the Bush tax cuts are not extended, in my opinion it is almost a lock that we go into recession next year, unemployment goes to 12%, and underemployment gets even worse. That is not a good climate for Obama and the Democrats in 2012. It is especially bad when you look at the number of Democratic Senate seats up for re-election that are in conservative states. The Republicans could take a serious majority in the Senate.

And then what? Right now Republicans are running on promises that they will not cut Medicare and Social Security, but are going to reduce spending and get us closer to a balanced budget. But everyone knows that the only way to get the budget into some reasonable semblance of balance will be to either cut Medicare benefits or increase taxes.”

There are only the two options. Yes, you can reform medical care, and I think much of Obamacare should certainly be repealed, but that does not get us anywhere close to dealing with the real issue, and that's a fact. There are tens of trillions in unfunded liabilities in our future, which must be dealt with.

Let me be very clear on this. I am not really worried about the supposed $75 trillion in unfunded Medicare liabilities in our future. That is an impossible number. If something can't happen it won't happen. Long before we get to that apocalypse, we find a bond market that simply refuses to fund US debt at anywhere near an affordable cost. Crisis and chaos will ensue.

People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them.

- Jean Monnet

The simple reality is that if We the People of the US want Medicare, in even a reformed and more efficient manner, we must find a way to pay for it. It will not be cheap. Raising income taxes on the "rich" is not enough. You have to go back and raise income taxes on the middle class, too. Oh, wait, that will be a drag on the economy and consumer spending. And in any event it will not be enough.

The only real way to pay for those benefits will be a value-added tax, or VAT. And while it could be introduced gradually, let there be no mistake that it will be a drag on economic growth. Government spending does not have a multiplier effect on the economy. It is at best neutral. What creates growth is private investment, increases in productivity, and increases in population. That's it. Tax increases have a negative multiplier.

A significant VAT along with our current income taxes will give us an economy that looks more like the slow-growth, high-unemployment world of Europe. Can we figure out how to deal with that? Sure. But it is not growth-neutral.

Republicans in 2013 will be like the dog that caught the car. What do you do with it? The last time they (embarrassingly, we) really screwed it up. The defining political question of this decade will not be Iraq or Afghanistan, or the environment or any of a host of other problems. The single most important question will be what do you do with Medicare? Cut it or fund it? Reform it for sure, but reform is not enough to pay for the cost increases that will come from an increasingly aging Boomer generation.

There is no free lunch. At some point, Republicans cannot run on "no cuts in Medicare" and "no new taxes" and be honest. At least not this decade. Maybe when we have cured cancer and Alzheimer's and heart disease and the common cold at some future point, medical costs will go down, but in the meantime we have to deal with reality.

You may be able to fool the voters, but you will not be able to fool the bond market. Not dealing with reality will create a very vicious response. Ask Greece.

And that is the national conversation we must have with ourselves. There is a cost to government. There is a cost to extended Medicare benefits. (I am blithely assuming we deal with all the "easy" stuff like Social Security, and make real cuts in other areas.)

Enough on medical issues. Let’s jump into the rest of the letter.