The Dollar Showdown

Rally On!

Whoa! The speculators had a field day today. Stocks soared once again today as investors continued to chase the rally. I have said this 100 times but I will say it again: There is really no fundemental reason for this rally. However, no one on Wall St seems to care!

This is one of those hold your nose and buy moments if you are a bull. The mutual funds can't afford to not participate as stocks continue to surge because they risk trailing their competitors. At the same time, retail investors start jumping back in again thinking the bull is back! At this point IMO, jumping in now seems pretty foolish after a 50% move because you missed it.

If you are conservative(like myself) and jumped the sidelines when the DOW touched 14,000, you need to put this move into perspective. You are still looking down and laughing at the bulls because they still trail you by 30% even after this move. 9+K is a long ways from 14K. You are still way ahead even if you got out at 11,000!

The Dollar, The Bond Vigalantes, and the Big Showdown

This is scary folks. Take a look at the dollar collapse over the last few days:

My Take:

I have been thinking a lot about the bond market and deficits lately, and after reading a great piece on this topic by The Daily Reckoning, my thoughts around what I think is going on became much more clear.

What I found interesting in the TDR piece was understanding who the real bond vigilantes are in this cycle: It's the Chinese and their massive treasury holdings.

We are headed for a huge showdown folks. A very smart influential Wall St executive friend of mine has always told me that the next war will be a financial one versus a war fought on the battleground. His biggest fear has always been China. He believed that a financial war was brewing between the US and China, and the result would decide which country would be the kings of the world financial markets moving forward.

I wasn't so sure about this idea when he shared it with me at the time, but I am starting to believe that he was right.

I believe the plummeting dollar is about to force a financial showdown between China and the US. A falling dollar will eventually lead to catastrophic inflation(look at oil and the commodities the last few days) if the US doesn't stop the spending and shrink its deficits.

China has consistently told our government that they will not tolerate inflation via a crashing US currency because it destroys the value of their massive US treasuries holdings. The US on the other hand is willing to tolerate inflation because they believe they MUST keep spending and bailing because they believe(foolishly so) that this will eventually result in an economic recovery.

If the US keeps spending and creating inflation, China may go tell them to pound sand and stop buying treasuries. This would then unravel any hopes for a US recovery because treasury yields would soar, and our ability to borrow would sharlply shrink unless we printed.

This tense situation basically puts both countries on a collision course with each other with the financial system hanging in the balance!

The Bottom Line:

The US has promised to reduce their deficits once a recovery begins. The problem is we are not recovering fast enough and this is putting massive pressure on the dollar. IMO, there is no possible way for us to recover fast enough to the point where we could start paying back these deficits without putting the economy in the crapper again because there is no catalyst for future growth!

The idea that the US thinks it can grow itself out of a $14 trillion deficit before inflation hits is ridiculous. This is now being reflected in the dollar and commodities. You can guarantee that China is not happy with what is going on with the shrinking dollar.

Making matters worse is the fact that tax revenues are collapsing which further reduces our ability to pay down debt. This was just released a few monutes ago by the AP:

"WASHINGTON (AP) -- The recession is starving the government of tax revenue, just as the president and Congress are piling a major expansion of health care and other programs on the nation's plate and struggling to find money to pay the tab.

The numbers could hardly be more stark: Tax receipts are on pace to drop 18 percent this year, the biggest single-year decline since the Great Depression, while the federal deficit balloons to a record $1.8 trillion.

Other figures in an Associated Press analysis underscore the recession's impact: Individual income tax receipts are down 22 percent from a year ago. Corporate income taxes are down 57 percent. Social Security tax receipts could drop for only the second time since 1940, and Medicare taxes are on pace to drop for only the third time ever.

The last time the government's revenues were this bleak, the year was 1932 in the midst of the Depression."

Yikes!

Take a look at our debt versus tax revenue that we have to pay it back:

Back to the Bottom Line:

As unemployment rises, our 70% consumer based consumption economy will not turn around because the consumer barely has a pulse. People do not have the ability to spend like they once did because their access to credit has evaporated. They are also saving more in order to both pay off their debts and ride out this nasty recession/depression.

There is no way we can create a recovery in time to please the Chinese when you look at how dire the USA's balance sheet is. This means the Fed doesn't have the ability to make good on their promises to China to reduce the defecit unless they decide to end the stimulus in order to control inflation.

The problem with this solution folks is this likely puts us in a deeper deflationary depression then the one we saw in the 1930's.

If we ignore the Chinese and keep spending(the most likely scenario in my view) then the dollar will continue to collapse and inflation will eventually cripple the economy.

Get ready for $150 oil, its right around the corner if the US doesn't back down from China.

Stay Tuned!