People keep talking about the economy recovery. But no one talks about why the economy is recovering.

As I mentioned time and time again, this is the first time in history that every major central bank in the world is printing money.

That means the world is piling on more debt than ever.

The greatest transfer of wealth is taking place right before your eyes.

Yet very few people grasp the severity of the situation.

Over the past few years, I have written diligently on what is really happening to the world's financial system; not only how it affects your wealth, but your very livelihood - and your kids too.

The rich are getting richer, and the poor are getting poorer. What makes this situation worse is that the general population has been manipulated to believe things are getting better.

But that's far from the truth.

Why Things are Worse, Not Better

The other day I had a conversation with a very bright and successful real estate agent. What started out as an exchange of views on real estate gradually escalated into a discussion about what caused the 2008 financial crisis and why things have only gotten worse since then.

Like the general population, she believed things are getting better. She also believed that Canada is nowhere near as bad as the U.S., especially in terms of leverage because of Canada's conservative banking system.

I didn't argue any of her comments, but I asked her, "What do you think caused the 2008 crisis?"

She replied as everyone else always does, "greedy bankers."

Then I asked her why she thought things are getting better.

She replied, "Well, housing prices are climbing back, jobs are coming back, and the stock market is doing extremely well."

She was right. Housing prices have been climbing, unemployment has been improving, and the stock market is higher than it's ever been before.

But that's not why things have gotten better.

So I explained.

The Truth About the Economy

Things have gotten better because the government, and the Fed, have decided to fix the problem with more leverage, more speculation, and more greed.

In other words, the same thing that crashed the market is now being used to fix it.

People have a very short memory. They've already forgotten that it was a low interest rate environment and ease of borrowing that led to the housing bubble in 2008.

They've already forgotten that borrowing beyond their means can lead to disaster.

If the U.S. single-handedly crushed the world economy and financial markets in 2008, what happens when the whole world plays the same game?

Borrow Lots, Achieve Little

Since 2008 the G7 has created around $1 trillion of nominal GDP activity, but have added nearly $18 trillion of consolidated debt, which now sits at a whopping - and new record - $140 trillion.

That means over the past five years, it took the G7 $18 dollars of debt - of which $5 trillion was provided by central banks (Fed, Bank of England, European Central Bank, and Bank of Japan) - to create $1 of growth.

The 2008 crisis was caused by over-leverage, yet over the past four years the consolidated debt/GDP ratio of the G7 nations has increased to an insane 440 per cent.

The real estate agent was beginning to see the picture.

However, she - like most people - thinks Quantitative Easing (QE) and all of these stimulus measures are a good thing because it gives everyone more money to spend which increases confidence.

And again, she was right.

Low interest rates and QE forces banks to lend and people to borrow.

The premise behind QE is simple: the more money we borrow, the more we spend, the more confidence we become, and our problems should solve itself.

But what she failed to mention is that all of that money needs to be paid back.

She didn't get it.

So I explained to her what printing money (or QE) really is.

QE in Layman's Terms

QE is a last resort to stimulate the economy when the cost of money (interest rate) is already as low as it can go.

I repeat, it is a last resort.

The money supply grows when a central bank "buys" financial assets, such as bonds, from commercial banks and other private institutions.

These commercial banks and private institutions now have more money on their balance sheet as a result of their "sales" and that means they now have more money to lend out.

(Conversely, if the Fed wanted to tighten the money supply, it will sell commercial banks financial assets. Since the commercial banks need to use cash to pay for them, it decreases the amount of money in the system.)

While the Fed, America's central bank, has a balance sheet (like all banks), it is the one and only bank that is never audited. That essentially means it has an endless supply of money.

Where Is the Money?

Trillions of dollars have been printed since 2008 and you might wonder where all the money has gone.

The agent did too. She asked, "Well, since trillions of dollars have been printed, it couldn't have all gone into consumer spending...right? Because of it did, we would have a much higher GDP as a result."

Right! She was catching on.

(You can go back to my Letter, "The Dramatic Drop" to understand more about money velocity, or rather how money enters the system)

The government wants the banks to lend so people can spend, but people can only borrow so much based on their financial situation.

All of the money sitting at the banks from their sales to the Fed need to be lent out, so that the banks can make money on the interest while fulfilling their obligation to the government and the Fed to lend and stimulate the economy.

Since the average American can only qualify for a small loan, the banks have to resort to other practices.

They lend to those who can afford to borrow lots.

And the only ones with the capacity to borrow billions trillions of dollars are big funds and traders who collateralize the debt with other assets, such as stocks and financial assets, or hard assets such as gold and real estate.

As I mentioned in my letter, This Could Kill the Stock Market:

"According to Bloomberg, The nation's (US) largest hedge funds borrowed more than $1 trillion as of the fourth quarter, yet only had net assets of $1.47 trillion:

"The nation's largest hedge funds had $1.47 trillion in net assets and more than $1 trillion in borrowings as of the fourth quarter, according to the first report compiled on confidential data they provided to the U.S. Securities and Exchange Commission.

...The funds reported having $1.47 trillion in net assets and $1.06 trillion in aggregate debt during the fourth quarter. Debt includes secured and unsecured borrowings for each fund and excludes "other significant

methods of incurring leverage," such as derivatives, according to the report.

...The report also provided details on the liquidity of the assets held by the funds.

Twenty-seven percent of their $1.47 trillion in net assets could be divested within a day, according to the SEC. Fifty-three percent of the net assets could be liquidated in a week or less, the large managers said, and 71 percent would take no more than a month to sell. Fifteen percent of assets would take more than six months to liquidate.

The agency also detailed how quickly the managers allowed their investors to cash out. About 7 percent of the $1.47 trillion could be withdrawn by investors in a day, and 24 percent could be taken out within a month. Investors could redeem about 59 percent of the total capital within 180 days, the report said. About 26 percent of capital would take more than a year to get back."

Not only are hedge funds highly leveraged, but their leverage is now likely much higher than the Q4 reports. If that is the case, then hedge funds are borrowing over $1 trillion.

Note that the above report only shows borrowing from the biggest hedge funds; it doesn't even factor in smaller funds or other non-hedge fund financial institutions.

A few years back when I predicted that the S&P will set new highs despite the slow and vulnerable economic recovery, everyone asked me why.

The agent was beginning to understand.

But she asked, "Okay, that's the reason stocks are rising, but how do you explain the growth in consumer confidence?"

Great question. The answer? Give things away for free.

Free Cars for Everyone

Ford and GM said this past August was the best month for car sales in seven years.

The whole auto sector is doing better and sales are soaring.

It has been President Obama's goal to turn GM and the American automaker sector around, which he said would provide jobs for Americans.

GM has restructured itself since its bankruptcy in 2009 and is now once again a leader in car sales. And with soaring car sales, you would think the economy would be in much better shape and provide many more jobs.

But you're wrong.

While auto manufacturing employment is up since 2009, and the motor industry has accounted for 15 to 20 percent of economic growth, it's accounted for only 2 to 3 percent of job growth.

Furthermore, middle-income jobs (such as autoworkers) made up 60 per cent of jobs lost in the recession, but lower-wage occupations have accounted for around 60 per cent of jobs gained in this recovery.

But there's an even bigger problem.

GM, now the leading automaker, hasn't risen from the dead because of its innovation or the quality of its cars.

It's sales are soaring because its practically giving away cars for free.

According to GM's annual SEC filing, GM Financial (GMF), the Company's in-house financing arm, reported that delinquencies grew by about $200 million to a whopping $933 million in 2012.

That's nearly $1 billion in delinquencies last year.

That means delinquent contracts in 2012 at GM represent 8.5 percent of all auto loans - higher than delinquencies at Ford, Toyota, and Honda combined.

How is that possible?

The Subprime Auto Market

85 per cent of GMF loans are subprime.

That means 85 per cent of GM's loans are high-risk loans made to potentially unqualified buyers. And the number of subprime loans are rising.

In 2011, 8 per cent of GM Financial loans were given to borrowers with credit scores above 660. Last year, only 4 per cent of GMF borrowers had credit scores above 660.

But that's not all.

Like subprime mortgages, subprime auto loans have also been turned into financial assets that are sold to the public who assumes the risk of those loans.

According to Deutshce Bank, the demand for asset-backed bonds linked to subprime car loans surged 20 percent to $12.9 billion this year, compared with the same period in 2012.

A couple of weeks ago, General Motors brought to market its first unsecured bond offering since coming out of bankruptcy, in a blockbuster USD 4.5bn deal.

These notes include $1.5 billion of 3.5 percent notes due in 2018, $1.5 billion of 4.875 percent notes due in 2023 and $1.5 billion of 6.25 percent notes due in 2043.

Generally, unsecured bonds return a much higher interest rate because of their uncollateralized risk. The GM terms not only show us how desperate investors are for returns in this low interest rate environment, but it also illustrates how the effects of money printing and low interest rates encourage even more leveraged risk.

Simply put, we're in a high risk, low reward environment.

Remember this:

"...We all know the story by now: Mortgages sold to people who couldn't afford them, or even sometimes understand them. Banks and investors allowed to keep packaging the risk and selling it off. Huge bets -- and huge bonuses -- made with other people's money on the line. Regulators who were supposed to warn us about the dangers of all this, but looked the other way or didn't have the authority to look at all.

It was wrong. It combined the breathtaking greed of a few with irresponsibility all across the system. And it plunged our economy and the world into a crisis from which we're still fighting to recover. It claimed the jobs and the homes and the basic security of millions of people -- innocent, hardworking Americans who had met their responsibilities but were still left holding the bag." - President Obama

The above was the remarks by the President on the Economy in Osawatomie, Kansas back in 2011 regarding subprime mortgages. Here's the full speech:

Here we are just a couple of years later and GM is not only increasing its subprime loans, but the financial instruments spun off from these loans are now higher than before.

Obama's goal was to revive GM at any cost - even if it means recreating another subprime scenario.

Back to Canada

My conversation with the agent reverted back to Canada and its strong housing market and conservative banking system.

She asked, "Well, Canada most certainly is doing better than the U.S., and we don't have the same major issues that caused their subprime market."

To which I replied, "For now...But do you know that Canadian household debt climbed to a new high in the second quarter this year?"

A few weeks ago, Statistics Canada told us that the ratio of household credit market debt to disposable income increased to a new high of 163.4 per cent in the second quarter.

That means Canadians owe just over $1.63 for every $1 in disposable income they earn in a year.

"Do you know what the household debt-to-disposable income ratio was in America in 2007, right before their economy went bust?" I asked.

163 per cent.

While these ratios are calculated differently in the U.S. and Canada, new statistics show that Canadians are now more indebted than Americans - even when adjusted for the differences*.

(*When adjusted for Methodological Differences in Canada/U.S. Calculations, the Canadian ratio is closer to 152 per cent, while Americans are at now at 140 per cent)

Furthermore, its becoming more expensive for Canadians to buy homes, leading to many borrowers who overextend their borrowing capacities.

New data from the 2011 National Household Survey shows us that 49.7 per cent of households ages 24 and under spend over the affordability threshold - defined as 30 per cent of total household income - on shelter costs including rent or mortgage payments, property taxes, condo fees and utilities.

Overall, 25.2 per cent of Canadian households exceed the threshold set by the Canadian Mortgage and Housing Corporation (CMHC).

The agent's demeanor had now turned a 180.

So I finally asked, "Do you remember what 2007 was like right before the crash?"

To which she responded, "Housing prices were soaring, unemployment was low, and the stock market was doing very well."

I continued, "That's right. But as we just discussed, all of that was the result of borrowing too much money...Where do you think we are now?"

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