Dollar decline or strengthen? Where do we invest next?

            All of the following experts expect the U.S. stock market to decline at some point in the future.  One interesting question is whether the dollar will continue to weaken or turn around and become strong. The answer to that question can affect future investment alternatives. 

            Some experts like Peter Schiff and David Tice believe that the dollar will loose value and we should expect inflation in prices and not lower commodity prices. If the dollar continues to weaken then perhaps as Tice suggests “Being in foreign assets, precious metals, and select equities may prove safer than shorts.”

            To read more on what Tice believes see Flaws in the Deflation Case  Note: The following is my summary of the linked articles.

            ”The majority of economists/analysts remain in the deflation camp.”  Deflation forces are three: 1. unemployment 2. falling household wealth 3. consumer debt. These forces require a free market to allow a deflationary correction, but the US economy is the “most manipulated and subsidized” in the world. [quotes are not for emphasis they are direct quotes from the article].

            The author of the article  believes that the Feds will continue to increase debt, which was their response to the existing crises.  He says that inflation will benefit debt holders “But like it or not, inflation will eventually benefit debt-laden companies with good cash flow (they get to pay off their debts with devalued currency). That’s a horrible model, but it seems inevitable

            The author agrees with some experts who are predicting an even deeper recession.  He feels the Fed’s will not curb inflation and will monetize the debt. [ie print money] He offers the suggestion that since Richard Fisher head of the Dallas Fed is predicting deflation that Fisher will not be concerned about curbing inflation, and he is the one fiscal conservative in the group.

            The author seems to make the suggestion that if the Fed does not monetize the debt the Federal Government will have to raise taxes, which he says may not happen because the taxpayer will not allow it.  “The American public is largely complacent. As long as you don’t raise their taxes or slash their benefits, rebellion is unlikely.”

            Deflation theory:

            On the opposite side of the coin we have Jeff Gundlach of TCW Calling for Deflation And US Dollar Rally.  Why should we follow his advice? His fund TGLMX: 10.13 +0.01 +0.10% did very well for investors.

            Gundlach “We’re basically borrowing money and calling it economic growth,” he said on Wednesday. “It’s not real economic activity.” This should be more than obvious to everyone who has a radio or television set. But what does it mean in terms of the inflation and deflation issue? The “cash for clunkers” program to Gundlach means deflation in the future. “Deflation is so strong that you can’t even sell cars unless you slash prices 20% through government subsidies,” he said.  Since many of the new vehicles that will be sold in the future arrive from foreign shores, what impact will lower prices in the U.S. have on those foreign producers, who also sell the same cars to other countries?

             The article seems to criticize the fact that “Gundlach sees such large debt defaults in coming years that he thinks the trend will cut the supply of dollars, pushing up the currency’s value.” My question is how that fact translates into lower commodity prices. Basically to lower prices the raw materials, taxes, and regulations have to allow for lower manufacturing costs. I would be interested in knowing how Gundlach sees that happening.  Also what about all the dollars that have yet to be placed into circulation when China and Japan cash in their treasuries? Gundlach doesn’t seem to be bothered by this question.

            There are deflationary signals: Rally in U.S. Gov bonds; downward prices in the DJ-UBS Commodity Index so Gundlach’s prediction at least in the short term has some merit.  But will his predictions survive monetizing the enormous national debt and the demand for dollars when foreign holders cash out of treasuries?

            A Very Different Picture in China:  

            Bank of China’s Zhu Sees ‘Bubbles’ in Asset Markets

            China’s economy expanded 7.9% in the second quarter of 09.  “The Shanghai Stock Exchange Composite Index has gained 61 percent this year, compared with a 20 percent increase in the MSCI World Index of 1,659 companies. House prices in China’s 70 biggest cities rose at the fastest pace in 11 months on record lending and climbing confidence, according to a National Bureau of Statistics report today.”

            China’s economy is being fueled by easy credit, but it has the production capacity to go along with new economic growth. That is something that the U.S. economy lacks.  China is the world’s third biggest economy.

            Central planning will work much better for China than it ever will in the U.S. Here is one simply example: “China Construction Bank Corp., the nation’s second-largest, said last month it will cut new lending by 70 percent in the second half from six months earlier to avoid a surge in bad debt.” Try cutting lending by 70% in the U.S. economy and see what happens.

            When the leaders do not have to worry about reelection they can do things like this: “The China Banking Regulatory Commission said on Sept. 3 it will implement stricter capital requirements for banks. Lenders were also required to raise reserves to 150 percent of their non-performing loans by the end of this year, up from 134.8 percent at the end of June.”  The Fed can’t come close to those numbers even if the survival of the U.S. economy depends upon it, and it probably does.

            When China stimulates its economy the money doesn’t go to the unemployed, or for food stamps, it goes into production i.e. “trillion yuan stimulus package and key industries including petrochemicals, steel and automakers.” That is the job producer that Congress cannot create because steel, petrochemicals and auto manufacturing are bad words to environmental activists, and the national media.

            While Congress is very likely to impose a penalty via the cap-and-trade policy on industry, China is cutting energy costs to stimulate its vast production capacity. “Zhang Xiaoqiang, vice chairman of National Development and Reform Commission, China’s top economic planning agency, said he sees “little bubbles” in the nation’s new energy sector and is looking into measure to curb excesses at an early stage to allow for healthy development for the industry.”