The Dollar’s Collapse Will Accelerate The Deflationary Sell-off Already Underway

The dollar's collapse will accelerate the deflationary sell-off already underway in US assets. To understand exactly how a dollar sell-off will kick deflation into high gear, it is necessary to understand the immediate effects of a dollar collapse and the structurally unbalance state of our economy.

The immediate effects of a dollar collapse

When nations around the world de-peg their currencies and the dollar is sent tumbling, two things will happen:

1) inflation and interest rates will spike up.
2) Commodity prices will more than double as the dollar loses its purchasing power.

These Higher commodity costs and interest rates will deal the death blow to our unsound economy

The structurally unbalance state of our economy

Over the two last decade, the unnaturally strong dollar and easy credit have warped the US economy, making it structurally unbalance. Here are some examples of what has gone wrong with our economy:

Oversized financial sector. In the last two decades, the financial sector became oversized relative to our economy (over 28%) by selling all manner of exotic financial products to investors around the world and building the biggest credit bubble in history. The growth of financials came at the expense of industrial sector, which has been decimated by the dollar's strength these last two decades.

b) Automakers dependent on cheap gas. The entire US Automaker sector is founded on the assumption of eternally cheap gas. With gas headed over 5 dollar and vanishing consumer spending, the entire US auto sector is gone.

c) Wanna-be-financials. Hundreds of companies took advantage of easy credit to develop their own in-house financial subsidiaries to help consumers finance purchases. GE, the automakers, and retailers like home depot used 0% financing and credit cards licensed to them by VISA and MasterCard to boost sales and fuel growth. With the economy entering the worst downturn in generations, these wanna-be-financials companies that dabbled in consumer finance are going to be struck by record defaults.

d) Debt funded stock buybacks—Hundreds of companies also took advantage of easy credit to finance stock buy backs. They are now having to roll over that debt at MUCH higher interest rates (GE is getting killed by this). If you own a stock which has done a lot buy backs in recent years, be VERY careful.

e) Outsourced manufacturing. In order to cut costs, companies have outsourced large parts of their manufacturing operations to lower cost labor markets overseas. Unfortunately, as the dollar collapses, the cost of oversea labor will increase in dollar terms, dealing a crushing blow to companies whose primary market is in the US.

f) Toxic assets. In every sector of the economy, corporate balance sheets are filled with toxic assets sold to them as 'AAA' investments by the financial sector. The reasons behind this mountain of bad debt are numerous: reckless lending (subprime mortgages), idiotic business models (bond insurers), mispricing of risk (overpaid financial wizards using flawed models no one understood), over-optimistic assumptions (housing prices will never fall), lack of transparency, etc… As a result, the financial health of companies across the economy is being undermined by these toxic assets.

g) Leveraged Stock Buybacks. Taking advantage of low interest rates, companies like GE issued large amounts of debt (commercial paper or corporate bonds) to fund share buybacks to juice profits and prop up stock prices. These companies are now having to roll over all that debt in a tightening credit market while consumer spending goes off a cliff, and their odds of long term survival are not good.

h) Bankrupt consumer. The US consumer is going to hell in a hand basket. At least a third of the economy (automakers, financials, etc) that he relies on for employment is about to be wiped out. States and local governments face massive budget deficits, which means more job losses, higher takes, and less government assistance/services. Gas prices are headed over 5 dollars a gallon, and this is a country with no public transportation where you need to drive everywhere. The consumer is also heavily in debt, with negative equity in his SUVs/homes and mountains of credit card debts. All this means a drop in consumer spending far deeper than anyone currently imagines, which will eventually crush an even bigger portion of the US economy.

What will be the effect of all this on US asset classes?

Here is a quick overview of what deflation and the dollar's collapse are going to do to US asset classes:

---Treasuries will be hit with deleveraging, a loss of faith in the US's creditworthiness, and inflation concerns.

---Bonds will be hit by deleveraging, default fears (especially for financials, retailers, and automakers), and inflation concerns.

---The tech stocks will be hurt as job losses, rising food/gas prices, and tightening credit cut in to what consumers have left for fancy gadgets, new computers, and flat screen TVs.

---Financial stocks will be hit by deleveraging, soaring default from all sectors of the economy, lack of a viable business model to replace securitization, failing off-balance sheet investment vehicles, inflation concerns, and shrinking dividends. (the entire financial sector is fundamentally insolvent).

---Automaker stocks will go to zero because SUVs are worthless in the land of 5 dollar gas.

---Retailers stocks will also be hurt as the drop in consumer spending results in their worst holiday season in decades.

---Makers/retailers of luxury goods and auction houses like Christie's will be slaughtered as their clients, America's richest, become poor quite fast.

---Manufacturers will be hit by higher cost for raw materials and sharp drop in demand.

---All stocks will be hurt by rising corporate taxes (government won't have a choice if it wants to keep funding its operations).

---All Stocks will be hurt by deleveraging, margin calls, and forced selling.

---All stocks will be hurt by concerns about inflation and the dollar.

Basically, as the dollar collapses, the declines in our credit and stock markets will turn into crashes that make 1929 look mild.

What won't sell off?

There are a few places left in the stock market for investors to hide as America's economy disintegrates:

---The few export oriented companies left in US, like coal producers.

---Unhedged gold mining stocks (and other precious metal miners)

---Multinational corporations which have the majority of their business outside the US, which sell necessities rather than luxuries, which don't have toxic assets on their balance sheet, and which haven't dabbled in consumer financing or debt funded share buy backs.

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