The United Kingdom's financial system is effectively bust. And other countries, including the United States, Ireland, Greece, Iceland and a dozen or more other nations are also basically bankrupt as their financial services infrastructure clings to life support, courtesy of national governments.

As the banks in these countries continue to falter and witness an implosion of their stock-market capitalization, it's only normal to expect currency weakness to follow suit. The pound is already in the basement -- down almost 30% year-over-year -- while the euro is cracking and the Icelandic krona has collapsed. Many other currencies have also declined sharply against the dollar and especially gold.  

For Britain, who delved heavily into mortgage derivatives and other synthetic securities to fuel the big boom over the last decade, the Piper has come calling.

Royal Bank of Scotland or RBS recorded the biggest corporate loss in British history yesterday with a massive $41 billion dollar loss. At this point the market wants total government nationalization of RBS.

The three largest UK banks have some $1.3 trillion dollars tied to commercial and residential property and structured credit -- with $140 billion dollars particularly toxic.

Now England will become the first major economy to guarantee toxic bank assets or effectively become one large credit default swap or CDS.

A credit default swap is essentially an insurance policy purchased as a contract protecting the owner of a bond against corporate or government default. Britain's credit default swap rates have surged over the last several months; it now costs more to insure against a British government debt default than Diageo, the world's largest spirits company.  

The United States will follow Britain's dangerous but necessary lead. President Obama has pledged to tackle bad assets and the Fed wants to head into this direction right away, despite former Treasury Secretary Hank Paulson's u-turn back in October.

The British Treasury will now insure banks against a wide range of risks tied to their busted balance-sheets, including residential mortgages, leveraged loans and other loans tied to domestic consumption.

The Anglo-Saxon economies historically follow the same boom-and-bust cycle. This is especially true in the post-WW II period where the United States and England share virtually the same growth cycle. Australia, New Zealand and Canada are also tied to this phenomenon. And now, so is the rest of the world. 

The global financial system remains badly fractured with the largest banks basically insolvent.

In this environment investors would still be wise to underweight stocks and other risky assets and diversify mostly in investment-grade corporate bonds, TIPs, mortgage-backed agnecy debt and some convertibles. Income is essential.