It was refreshing to read Anatole Kaletsky's contrarian piece in yesterday's London Times; it should be required reading for all investors. "I am probably the only economist left in the world who still believes that a U.S. recession is likely to be avoided," says Kaletsky. Given the massive amount of doom and gloom in the financial press, it's important to try and understand the contrarian argument.

The core of Kaletsky's argument is that we're only seeing sector-specific slowdowns in the U.S., and that "problems affecting only one or two parts of the economy are a continuous feature of any market economy with its constant variations in demand and supply for particular products and services." But surely the financial and housing crises in America are now so severe that there can be no hope of avoiding a self-sustaining downward spiral? Kaletsky disagrees, and offers three reasons for continuing to resist the consensus view:

"Remember Friday, March, 14 2008: it was the day the dream of global free-market capitalism died," says the Financial Times' Martin Wolf. "For three decades we have moved towards market-driven financial systems. By its decision to rescue Bear Stearns, the Federal Reserve, the institution responsible for monetary policy in the U.S., chief protagonist of free-market capitalism, declared this era over."

Mr. Wolf argues that market deregulation has reached its limits, echoing Joseph Ackermann, chief executive of Deutsche Bank, who said that he "no longer believes in the market's self-healing power". Mr Wolf adds: "If the U.S. itself has passed the high water mark of financial deregulation, this will have wide global implications. Until recently, it was possible to tell the Chinese, the Indians or those who suffered significant financial crises in the past two decades that there existed a financial system both free and robust. That is the case no longer. It will be hard, indeed, to persuade such countries that the market failures revealed in the U.S. and other high-income countries are not a dire warning. If the U.S., with its vast experience and resources, was unable to avoid these traps, why, they will ask, should we expect to do better?"

A recent Barron's article points out that "gold and copper are each down 12% from the all-time highs seen on March 17 and March 6, respectively, while crude has fallen 11% from its March 17 high. London International Financial Futures Exchange sugar and cocoa are off 25% and 21%, respectively, from recent highs, while Chicago Board of Trade wheat has slipped nearly 20% since March 13." Is this the end of the commodity bull run?

Please understand that I'm not trying to predict any long term trends with this piece. I'm only trying to guess the direction of commodity prices over the next year. To provide focus to this discussion, I will consider the following issues:

Ask yourself a simple question: Do you believe that the U.S. dollar will appreciate over the next decade?

If you answered "Yes" you should be buying stocks. If you answered "No" you should be getting ready for a painful bear market. The argument here is simple, and is based on four assumptions:

Several analysts expect the U.S. dollar to rebound in the second half of the year. A slowing U.S. economy always affects the rest of the world with a delay, they say, and most of the bad news may already be priced into the greenback. "For Euroland, historically, the delay has been one or two quarters," notes Stephen Roach at Morgan Stanley. Analysts like Mr. Roach argue that central banks that proactively cut rates to bolster growth (like the Fed) will now see their currencies rally and central banks that don't cut rates will see their currencies weaken. The implication here is that investors will move money away from yield and turn their focus to areas of growth. Going by this logic, the U.S. dollar should benefit from the Fed's amplified focus on growth.

But what happens when the Fed's monetary policy fails to work? "Since the start of the global financial crisis last August, monetary policy has been remarkably ineffective," writes Wolfgang Münchau at the Financial Times. "We may even be in a situation where low interest rates give us the worst of all worlds: no stimulus in the short run, and a rise in inflationary expectations in the long run." He adds: "Among the various channels through which monetary policy affects the real economy, the credit channel is one of the most important. If real-world interest rates are determined independent of a central bank's monetary policy, the effect of monetary policy on economic growth is correspondingly reduced."

The theory of decoupling suggests that emerging markets have broadened and deepened to the point that they no longer depend on the United States for growth, leaving them insulated from a U.S. recession. Several analysts have claimed that decoupling is a load of rubbish, while others swear by it.

One of the factors complicating the decoupling debate is the lack of agreement on a definition. If we look at the performance of emerging market stocks over recent weeks, it appears decoupling is a fairy tale. But arguing that a falling stock market signals an economic downturn is too simplistic, since there are many factors that can lead to selling of stocks. I argue here that decoupling is essentially a theory about how commodity prices react to a U.S. recession.

Solar stocks have seen a sharp pullback since the start of 2008, and short-term rallies from current levels should be expected. Upcoming catalysts for near-term rallies include the announcement of new supply deals, better than expected earnings results, short squeezes and the potential for supportive legislation being passed. The more important question investors will need to ask: Are solar fundamentals deteriorating? Banc of America analyst Eric Brown recently suggested that solar will soon follow the trend of ethanol stocks, where attractive valuations can be trumped by deteriorating industry fundamentals. Several analysts have criticized the Banc of America note, arguing that solar stocks will continue to shine.

It is refreshing to hear disagreement among analysts covering the solar sector, and this is most likely a reality check after the runaway gains seen among solar stocks in 2007. We will discuss the industry outlook first, and then focus on the specific case of Trina Solar (TSL).

Financial firms have so far announced losses totaling around $160 billion, and UBS feels there could be a total of $600 billion in losses triggered by the subprime collapse. There is more bad news to come, and central bankers know it. If UBS is correct, we've only seen the tip of the subprime iceberg, and central bankers will have to remain flexibile to effectively deal with upcoming challenges. I don't doubt that the dollar's long term trend is down, but I argue here that coordinated intervention to give the U.S. dollar a short-term (2-5 years) lift may be an interesting idea for central banks to consider.

"The already undervalued dollar won't stop falling until it is stopped via coordinated intervention," said Morgan Stanley's Stephen Jen in a note published in December. "While the preconditions for such an action have not yet been met, uncoordinated verbal intervention has clearly commenced, validating the notion that the costs of a weaker dollar are quickly catching up to the benefits for most countries in the world."

I'm not going to pretend to know how to pick a bottom for stocks, but if we dissect the anatomy of a bear market we might understand why stocks markets eventually recover.

Anatole Kaletsky, a columnist at The Times, wrote a brilliant piece on bear markets in a recent publication. "When we look back through history - or think about the underlying economics of business cycles - we realize that every financial crisis and bear market in the past has been a buying opportunity because we can see, with hindsight, that the world never did come to an end," he says. Kaletsky makes an important observation: "If everyone in the market knew that previous financial crises and bear markets always created buying opportunities, then a new bear market could never occur." Overly simplistic? Logically correct?

It's probably fair to say that the most important diplomatic relationship in the world is between the U.S. and China. Unfortunately, the relationship is souring and could get much worse. "Alas, the U.S. is mostly to blame for this," said Nicholas Kristof in a New York Times column. "There are plenty of legitimate reasons to be angry with China's leaders, but its trade success and exchange rate policy are not among them. The country that is distorting global capital flows and destabilizing the world economy is not China but the U.S." He adds: "American fiscal recklessness is a genuine international problem, while blaming Chinese for making shoes efficiently amounts to a protectionist assault on the global trade system."

China has been a convenient scapegoat for politicians, and now China is being blamed for exporting inflation. Is this political spin, or is there a real danger of higher inflation being imported from China? Why are some so eager to blame the Chinese for higher inflation when the Fed's policies could be to blame for rising prices?

U.S. stocks markets appear to be in the process of finding a bottom, and it seems likely that we may soon see a rebound. "If we're in a recession now, which is pretty likely, we've probably seen most of the worst of the downside to the stock market," said Jennifer Ellison at Bingham, Osborn & Scarborough. "The market tends to rebound when the economy reaches its worst quarter."

I feel that a rebound from current levels will probably be a suckers rally, for reasons I will now explain. Apologies for the length of this note, but I've tried to summarize a few of the bearish arguments in 7 points:

An article published by The Telegraph newspaper suggests Japan is the next sub-prime flashpoint. Ambrose Evans-Pritchard says "there is still $300 billion of bad debt out there, and Japan could be hiding most of it." Evans-Pritchard discusses the nagging fear that Japan's lenders - the conduit for the world's greatest stash of savings - have taken on a far bigger chunk of mortgage securities, collateralized loans obligations and other exotica from America's structured credit boom than they have yet revealed.

"Americans and Europeans have so far confessed to $130 billion of the estimated $400 billion to $500 billion of wealth that has vanished into the sub-prime hole," he says. So far, Japan's biggest three banks have admitted to just $4.7 billion in total losses between them. "Somebody, somewhere, must be sitting on a vast nexus of undisclosed losses." Evans-Pritchard asks: "Where have the Japanese recycled the quarter trillion dollars they earn each year from their surplus? Official data shows that their holdings in U.S. Treasury bonds have not risen." The implication here is that Japanese savings may have gone into higher yielding subprime investments instead of safer and lower yielding U.S. treasuries.

Judging by this week's selling frenzy on Wall Street, it looks like the market has finally started pricing in a worst case scenario for the U.S. economy. And the time has come to ask some important questions. Is it safe to say that the recession is finally here? If we are in a recession, how long will the recession last? Will heavy consumer debt, a growing federal budget gap, and rising prices make this recession worse than Americans have experienced over the past two decades? Will the situation evolve into the worst financial crisis since World War Two? (By the way, legendary investor George Soros seems to think so.)

Sometimes the questions are more important than answers, especially in the chaotic environment we now find ourselves in. The right questions can act as compasses to steer us through this turbulent time. I'm not going to pretend I know the perfect questions to ask, but here's the biggest question on my mind:

There isn't a clear consensus on the FOMC rate decision, but most observers think the Fed will cut interest rates by 50bps. Of the 86 economists polled, 49 expect a 50bps cut, 23 expect a 25bps cut, while 13 expect rates to be left unchanged (the one remaining economist believes that there will be a 75bps rate cut). The U.S. short end is pricing in a very high probability of a 50bps rate cut, and Bernanke probably doesn't have the credibility to take on odds like that. "The Fed is still going to do a 50 basis points rate cut," said Michael Darda at MKM Partners. "I don't think they're going to run the risk of disappointing what they believe are very fragile credit markets."

So, let's assume the Fed cuts by 50bps. How will the market communicate a belief that the Fed is getting ahead of the curve? A useful indicator may be EUR/USD. "Investors are starting to ask whether central banks that proactively cut rates to bolster growth will now see their currencies rally and whether those that don't (will) see their currencies weaken," said UBS in a recent note to clients. This trend may already be evident in the price action of the greenback in the aftermath of last week's emergency rate cut.

That's probably what the Fed chairman said Thursday morning when he woke up and saw the headlines. As it turns out, Jerome Kerviel is a 31 year old Frenchman who enjoys judo and sailing. He worked as a trader at Societe Generale, and somehow managed to lose almost €5 billion in a series of complex, concealed deals on European stock derivatives. Kerviel's colleagues described him as a "computer genius" who was allegedly able to hack into the bank's computers to hide his reckless trading.

The Fed didn't know about Kerviel's shenanigans when they cut interest rates by 0.75% on Monday, and it now looks like the Fed's biggest emergency rate cut ever may have been sparked by a lie. Events unfolded like this: Kerviel screwed up on Friday last week, when he failed to disable the bank's automatic alert system, and his irregular trading suddenly showed up. Societe Generale's bosses grilled him on Saturday night, and the bank's management decided to unwind all the out-of-money trades on Monday. The unwinding of such a massive position put immense pressure on the futures market, and it started looking like a manic Monday. Other traders saw the plunge in futures amid massive and mysterious selling, and even though the U.S. markets were closed for Martin Luther King Day, they start selling everything else.

"Housing is not the only asset against which banks have been making sub-prime loans – there are shares as well," warns Alan Kohler at BusinessSpectator.com, in a blog written earlier today. "After a long period of cheap money and an unusually long and very strong bull market in shares there is now a large but unknown amount of leverage in the share market and the derivatives connected to it. And shares are now doing what the housing market did – that is, falling," he says. He goes on: "What might be called the share market's sub-prime problem has not surfaced and it is earnestly to be hoped it does not."

Unlike shares, Kohler argues, residential real estate is an illiquid market, so any price contagion is slow moving. "In the very liquid stock market, this process is much faster and much more dangerous. The stock market is falling around the world as banks confess to the bad loans they made against housing." Kohler asks: "How many bad loans were made against shares? Margin calls force highly leveraged investors to sell shares, driving prices lower quickly and sparking more margin calls. An avalanche can develop, as happened in October 1987."

Rumors of an intra-meeting cut before the official Jan 29-30 gathering refuse to go away. Some traders say that the FOMC will wait for inflation data on January 16 before deciding whether to cut interest rates between meetings, while others say that the FOMC will cut rates shortly after Bernanke's testimony before the house on Thursday January 17. Some analysts worry that the market is just too aggressively priced to disappoint, as futures markets have already positioned for an interest rate cut of 75bps by the end of the month.

"The real problem with the market is confusion," says Doug Roberts at ChannelCapitalResearch.com. "There is concern the government itself is detached from what is going on." In hindsight, if we're moving into a recessionary period or in one, it certainly would suggest the Fed's been too tight for too long. Will Bernanke now take dramatic action, perhaps cut interest rates before the month-end meeting, in an attempt to show the markets the Fed is not out of touch with the situation?

Investors have been fretting about a U.S. recession for months, and recent polls suggest a heightened level of economic anxiety among Americans. Assuming that we go into a mild recession, is this the time for solar investors to jump ship? To the contrary - a recession might provide some attractive opportunities in the solar sector.

A recession may boost the supply of polysilicon

"Climate change will likely affect economies and financial markets by causing shocks to long-term growth prospects and shifts in the relative price of carbon-intensive goods," said Morgan Stanley's Elga Bartsch in a recent research report. "Globally, climate change will likely cause stagflationary pressure."

Because "stagflation" sounds a hell off a lot scarier than "recession" you'll probably be hearing a lot about stagflation in the financial media over the coming weeks. By definition, stagflation is a period of time characterized by high inflation and slower growth. This presents a major problem for central banks, as they need to decide which problem (growth/inflation) they should tackle first. Periods of extended stagflation can cause great damage to central bank credibility. When economies go sour, and politicians start playing the blame game, central banks are the obvious (and easiest) targets.

Former Fed Chairman Greenspan said on Sunday that the U.S. economy is showing early signs of stagflation. It looks like the financial media has quickly grown tired of writing about the recessions and all the associated doom and gloom, which is why they are itching to jump on the "stagflation" bandwagon. A few observations:

Policy dilemma: Stagflation presents a problem for central banks, as they need to decide which problem (growth/inflation) they should tackle first. Futures trading shows that the market is betting the Fed will remain focused on supporting growth. Some analysts say central banks should ignore the threat of inflation, since debt deflation poses a far greater risk. Graham Turner of GFC Economics says Japan's decade-long struggle to escape the grip of deflation was caused by the failure of its central bank to cut interest rates quickly enough. "Today, central banks in the west are fretting over the risks posed by higher oil and food prices. But the lesson from Japan should be clear."