A bearish frenzy has developed in the US dollar, and is probably the strongest consensus I've seen since the bullish stampede in oil futures crashed last Summer. With publicity hungry commentators from historian Niall Ferguson to journalists spinning lurid Chinese/Arab conspiracy theories weighing in with their economic insights, and hedge funds leveraging up aggressively again on the global carry trade using the dollar as a 'free' funding currency, it's time for a reality check. There is no alternative to the dollar as the global reserve currency for the foreseeable future; while the dollar's share of CB reserves has declined from 72% to just over 62% this decade, this is the result of the Euro's emergence, with the Yen still a paltry 3% of global forex holdings.

Total dollar holdings have steadily risen, and even this year, China has continued to accumulate dollar assets, while grumbling about US economic policy. It will be at least a decade before Yuan convertibility is a real prospect, and only then if China can radically overhaul its financial markets in the meantime, developing deep capital markets and hedging mechanisms and gradually opening its capital account. At the moment, even in Hong Kong, less than 2% of trade is conducted in Yuan. As for that complex proposed IMF basket currency, which dollar bears offer as a real alternative, call me when a Colombian drug smuggler is caught with a suitcase full of the things.

One of the most remarkable economic reversals over the last decade has been the impressive macroeconomic discipline shown by leading emerging markets from Brazil to India, while developed nations such as the U.K. and U.S. have become increasingly reckless and profligate. While the former have been steadily re-rated by investors leading to a huge secular bull market in emerging market equities and bonds, the latter have yet to pay the price for their growing fiscal irresponsibility.

Argentina's troubled history in recent decades leads many to forget just how prosperous and advanced the country was a century ago. In fact, it was one of the ten richest countries in the world on a per capita basis until the 1930's. Any analysis of the country's stunning decline into inflation and dictatorship a few decades later must begin with the role of an entrenched economic elite who pursued their narrow interests regardless of the national cost. Rather than investment bankers, Argentina had a few thousand elite landowners who dominated the economy via agricultural exports. The pursuit of naked self-interest by these 'oligarchs' led to an increasingly unbalanced economy that underinvested in education and infrastructure and was dominated by inefficient monopolies protected by political patrons. That effort to protect the status quo at all costs via a captive political system led to the failure of attempts to modernize the economy and income inequalities growing to a destabilizing extreme.

After a stunning six-month rally in equities, commodities and corporate bonds, we are reaching a critical juncture for markets, which have swung from despondency to euphoria since March. Incoming data have moved the investment debate from whether a recovery is imminent to how strong and durable it will prove. I said back on March 10th that:

'Equities are now cheaper than for several decades on a cyclically adjusted earnings basis (and versus bonds) and stand at an extreme oversold level only seen a few times in the last century.'

Are Chinese officials about to panic and rein in the reckless bank lending that has fuelling nascent bubbles in local real estate and equity markets, and indeed artificially boosting commodities such as copper? While investors have cheered China's latest Q2 GDP growth of 7.9% as evidence of the country's policy success, they may be missing a hugely destabilizing spiral in monetary policy that is generating it. The country looks set this year to generate new bank lending equivalent to over 30% of GDP, or twice official targets, while money supply is growing at an annualized 26%. That's enough to make even Alan Greenspan in his bubble blowing heyday blush, and bubbles are blowing aplenty in China.

The quality of most of these rapid fire loans dictated by Beijing is surely abysmal. About $170 billion of Chinese bank loans are estimated to have been funneled into the Shanghai stock market in the first five months of 2009, or 20% of the total new loans banks made in that time period. Is it any surprise that China has just surpassed Japan to become the world's second largest equity market, and the best performing this year? I suspect another large chunk of that lending has found its way into speculative commodity stockpiling, as well as the real estate market. It's a bit rich that Chinese officials are criticizing US economic policy when they are essentially following the easy money credit boom model in order to forestall a cyclical economic recession. China can certainly achieve its talismanic 8% growth target by throwing vast resources into mechanical short-term growth objectives, but the question is whether these policies are sustainable or simply delay the necessary re-balancing of the economy away from manufacturing and infrastructure investment toward domestic consumption. Investment productivity is appalling, and has been declining for a decade; it is very likely much of the stimulus spending will be a total waste. Far from 'leading' a global recovery (unlikely anyway as it only comprises 8% of global GDP), China will be among the last countries to escape from the effects of the global crisis, being trapped in a deflationary trap of chronic export overcapacity as its foreign consumers deleverage over the next few years. It seems doomed to repeat Japanese policies of the early 1990's, which left that country carpeted in concrete but still mired in recession.

Friday's announcement that the US savings rate has hit an annualized 6.9%, the highest in 15 years (albeit boosted by transfer payments), confirms my view that we are seeing a huge cultural shift in US consumer behavior.

One of the mysteries of the slump has been how international trade volumes have collapsed far faster than reported growth would imply, and that would be explained in part if US consumer spending had been even higher in the boom years than officially reported, and thus the retrenchment as cash savings soared has sent shock waves across Asian and European exporters.

While the long end of the US bond market has been selling off for several weeks now, with 10 year yields over 3.9% and approaching twice the levels seen at the peak of the depression / deflation hysteria, late last week 2 year bonds also began to slump dramatically. Yields surged 34 bps on Friday and the market is now implying a Fed rate hike by end 2009, and a series of quarter point moves every couple of months through 2010. This move, if sustained, has major implications across asset markets.

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Back on December 10th, when many momentum chasing oil analysts were forecasting $25 crude, I wrote here on Seeking Alpha that:

'While demand destruction will cap upside to maybe $80 through 2009, the collapse in desperately needed investment spending, as production in key exporters like Mexico collapses, is setting us up for an inflationary surge in energy prices when the world economy inevitably recovers post 2010. Long term production exposure via oil majors and second-tier exploration plays with proven reserves is now very attractively priced (although oil service stocks will be impacted by slumping E&P spend).'

Sterling is now trading at its highest level of 2009 on a trade weighted basis. Back in February, celebrity pundits like George Soros and Jim Rogers were resolutely bearish not only on Sterling, but the UK economy. In fact the ever quotable (but rarely right) Rogers said on Jan 21:

“I would urge you to sell any sterling you might have...it’s finished. I hate to say it, but I would not put any money in the U.K.”

On the 10th of March, as the deflation panic reached a crescendo, I wrote here on Seeking Alpha that commodity markets were pointing the way to an upturn, and diverging hugely from equities:

My overall view is that fears of economic Armageddon have been grossly exaggerated and that the US is in better economic shape than the merchandise exporters of Asia and Europe, whose economic models are doomed in the face of structural manufacturing overcapacity. The unprecedented global fiscal and monetary stimulus will gain traction in the next few months and generate a sub-par but real recovery, led by the US, in 2010...equities are now cheaper than for several decades on a cyclically adjusted earnings basis (and versus bonds) and stand at an extreme oversold level only seen a few times in the last century.'

Unfortunately not, but you might think so judging by the outbreak of bullishness from US investment banks. Goldman recently upgraded GDP growth from 6 to 8.3% and Morgan Stanley from 5.5 to 7% on the back of a successful implementation of the $586bn stimulus plan and astonishing bank loan growth of $680bn in Q1.

No worries about money velocity in China; the advantage of being a centrally planned economy with state controlled banks is that money creation can be channeled directly by diktat to consumers and firms (although the quality of those force-fed loans will inevitably be direm I suspect much is leaking into stock market speculation and renewed commodity hoarding). I've never been in the depression/deflation camp and have argued consistently for a muted recovery in the US in 2010 generated by the huge stimulus applied, but the brutal reality is that the Chinese growth model is broken in a sustained deleveraging scenario for its foreign consumers. It is telling that the country's imports from Asia are falling even faster than its exports, and that both commercial and residential real estate prices are slumping on massive excess supply.

Capt. Kirk: What would you say the odds are on our getting out of here?

While ETF demand for gold has surged this year (though it's now stalling), investment demand still accounts for less than 25% of the total. I've been bearish since the latest spike above $1,000 in mid February (and advocated Platinum as an alternative exposure with cyclical recovery upside, see Platinum: The Poor Man's Gold?). It's important to take a strictly agnostic view of markets and look at any asset on its supply/demand fundamentals; these have been deteriorating for gold. On March 6th I wrote regarding the dramatic outperformance of the dollar over gold:

The irony is that just about every goldbug was also a convinced dollar bear a year ago, and their emotionally charged analysis has proved utterly misconceived in a deleveraging global economy.

On January 27th in Japan: Will the Yen follow the Economy Down? , I sent a trading alert to subscribers, warning that the Japanese Yen was extremely overbought, and ripe for a reversal against consensus:

At current levels sub 90 on the cross rate, any return of risk appetite by Japanese retail investors or signs that the yen carry reversal has run its course could send JPY spiraling downward back through 100 very fast indeed, with a possible trigger being intervention in the currency markets by the BOJ. I'd expect the Yen/$ rate to be in the range of 105-115 by year end, assuming some signs of a US economic upturn by then and a recovery in Japanese retail risk appetite. For those seeking exposure to a possible trend reversal, YCS is the Proshares Ultrashort Yen ETF, but currencies are notoriously volatile so caveat emptor.

While equity markets are legitimately catching a reflation bid as the economic freefall reflected in incoming trade and industrial production statistics begins to level out, it's crucial to take a realistic view of the sort of recovery that is likely in 2010 and beyond. A key constraint will be the enormous and historically unprecedented leverage the US economy has accumulated over the past 15 years. In recent years, it has taken over $5 of new debt to generate an incremental dollar of US national income, a ratio up 70% in a decade.

Debt, like any economic factor, suffers from diminishing marginal returns. US gross national debt/GDP will rise to 82.5% in 2010 (up from 55% in 2000) according to OECD projections, after running at least a 12% fiscal deficit this year. Globally, only two other major economies, Japan at 177% and Italy at 115% will have higher debt burdens, but both have enormous private sector savings and little personal debt. Household mortgage and financial sector debt both doubled from 2000 to 2007 from a base that was itself an all-time high.

Back in December, in Oil: From Bubble to Bust...and Back Again? I again took a contrarian stance on oil, having turned ultra bearish last spring as the speculative bubble peaked, stating that:

A blind monkey throwing darts would beat the average investment bank oil analyst, whether forecasting weekly inventory levels or the future oil price. At the peak of the historic investment bubble in oil futures back in July, they were falling over themselves to predict $170-200 oil in 2009. Now it's $25.

It is astonishing that four months after the election, not a single Treasury Under-Secretary or assistant has yet been appointed, leaving poor Tim Geithner home alone. Several weeks ago, ex Fed Chairman Paul Volcker called this delay 'shameful'. Partly, this chaos reflects the santimonius and impractical ethics standards set by the Obama administration, which have scared off many prospective candidates. In the Great Depression, FDR hired Wall Street operator and bootlegger Joe Kennedy to run the newly created SEC on the basis that it takes a crook to catch one. Instead we're getting yet more lawyers, and even they can't get confirmed by Congress, which is dangerously grandstanding at a time we need a sense of urgency. It's strange that key State Department officials, from Hillary Clinton downwards, were selected even before Obama's inauguration and dozens of them confirmed by Congress in the past two months and yet the economic team is in such disarray that it is proving incapable of launching a coherent response to the ongoing financial crisis.

This is causing serious concern internationally, as well as in the markets. The French finance minister said recently that it was 'imperative' for the United States to get its banking system up and running. 'The successive announcements by Treasury Secretary Tim Geithner, gave markets an impressionist sentiment,' she said. 'If they reacted badly, it's maybe because they sense the unfinished side of these plans.' That's a fair analysis. Aside from the lack of a team at the Treasury to implement policy, however half-baked, the nature of the relationship between Larry Summers (Chief Economic Adviser), Geithner, and Paul Volcker is clearly tense, perhaps because it has been so poorly defined by Obama himself. Volcker has blamed Summers for slowing down the effort to organize the recovery advisory board he chairs. He has also complained that Summers doesn’t regularly invite Volcker to White House meetings and is unwilling to collaborate on policy ideas. It all sounds like the kind of petulant behaviour that isn't tolerated at my son's nursery school.

Beached whales tend to explode as they decompose, spreading a stinking mess all around unless swiftly disposed of. So too for dead banks. This week's relief rally on bank declarations of 'profitability' is a classic Dead Cat Bounce in the context of looming insolvency for several leading names, however lax the new Treasury stress tests prove. We face $1.6 trillion in ARM resets between now and end 2012; the $790bn outstanding in credit card debt is already experiencing 7.8% charge-off rates. Even with a soft-focus mark-to-market rule, banks face a Tsunami of write-offs across every credit segment that will rapidly overwhelm their current anemic capital base. Let's get some perspective. The financial collapse that has engulfed the world economy can seem overwhelmingly complex, but in essence it boils down to two interacting financial theories that were tested to destruction.

The first was that securitization, the slicing and dicing of individual asset risk at any given bank to be parceled up and sold on, would lead to a more stable financial system by limiting the balance sheet concentration and hence vulnerability to external shocks of each institution. Risk was to be scattered to the four winds.