A Crippling Toxic Cocktail

By Jen Bawden
December 30, 2007

Other than have your cake and eat it too, my motto is “hope for the best and plan for the worst”. That being said, I suggest you fasten your seatbelts because the 2008 roller coaster ride is about to begin.

In a world of instant gratification where each days news effects minute to minute trading, it is increasingly important to take a macro view.

In October 2000, the Euro was worth 82 cents US. It now hovers around $1.30, that’s a 37% drop in value of the dollar. I consider that a pretty massive inflation of our dollar’s buying power. Which leads us to – Bernanke’s current dilemma. Wall Street and the politicians are putting serious pressure on the Fed to lower interest rates to calm the markets and stop a housing disaster. But, as interest rates drop, our foreign buyers move from the dollar to more attractive investments elsewhere.

If China even hints that they will diversify the dollar trembles. And so it should. China has 1.1 trillion US dollars in reserve. That’s equivalent to approximately 10% of our national debt! So the US dollar is at their mercy. Add to that billions in Saudi and Arab Gulf states, well, it is as politically complicated as controlling your mother in law and your ex wife. Good luck.

Some still think the credit crunch will not spill over to Main Street. It seems so obvious to me that the credit bubble was Main Street’s engine.

Reluctant to lose market share to competitors in the feverish Real Estate speculation, enthusiastic lenders forgot to ask how borrowers could pay back interest if new loans dried up. They practically gave away credit on every street corner forgetting that 70% of American people live paycheck to paycheck. Americans have learned well from their role model Uncle Sam, who has racked up a quagmire of federal debt. Everyone seems to forget, it is someone else’s money and debt eventually has to be paid back! An implosion was/is inevitable.

I hear many smart financial people say “but Americans buy everything in dollars so it won’t really effect us much” and “it is great for increasing our exports” they add. Yes it does at first, then it reverses as products aren’t sold on price alone but design, promotion, etc. To them I say ‘foreign countries and Americans sell commodities at the international price on the Chicago market.Cocoa bean, chocolate, beef (rising because of the cost of feed) oil, plastics and soybeans are all paid in US dollars at international prices. (Wheat has almost doubled!)

The thought that you will not even hear whispered by bankers or politicians is that an unhinging of the reserve currency could happen and that a sudden dive by the dollar would cause financial panic, a plummeting stock market, oil priced in the US dollar would rise to way over $100 a barrel and the gold price, which has been shouting inflation and dollar crisis, would quickly jump over $1000 an ounce as investors seek protection in safe havens.

The Government’s reserves would be gone in a few days if they had to support a dollar dive. Conversely, If we keep our dollar strong, foreign capital from the developing world will buy US bonds and help finance the huge liabilities of Social Security, Medicare and interest on the national debt!

My prudent wasp grandmother would certainly have prescribed a tonic to strengthen the dollar by recommending we learn to live within our means and not take on any more debt!

The second biggest unspoken fear is that unprecedented seizing up of financial markets caused by the mortgage credit derivatives could bankrupt businesses unable to raise funds, cause more large banking layoffs, and put some highly leveraged hedge funds out of business (some are leveraged 50x, watch for an implosion!) and, in a worst case scenario, cause line ups at banks as witnessed in England just several months ago.

Just five banks control over 97% of the derivatives in the US; JP Morgan Chase, HSBC, Citibank, Bank of America and Wachovia.

Warren Buffet called credit derivatives ‘financial weapons of mass destruction.’ Add to the martini baby boomers controlling 20 trillion in assets, beginning a massive migration into retirement and selling stocks and bonds.

Developing countries like China and India will be crucial in absorbing this slack over the next 20+ years. The baby boomers retirement, stealth inflation, lowering interest rates, a consumer loaded up with debt, the housing meltdowns, derivatives that bank supervisors do not even understand, new post-Enron accounting rules forcing CEO’s to come to Jesus or go to jail and the US dollar held hostage by China and Arab Gulf states are a toxic and dangerous cocktail.

A critical balancing act will be needed to keep the US economy from spiraling downward.

To not only make money in a bear market but to preserve and safe keep capital, allocations should be defensive. A super virus in interconnected global markets could spread very quickly plaguing even the darling China and emerging markets.

Cash in the bank should be in a T-bill sweep avoiding money market sweeps and, if the dollar rebounds, I’m looking at Australian and Swiss T-bills to mitigate the associated risks of a possible continued declining dollar.

Venture capital will become much more cautious. But investing in private recession proof businesses with enough funding to make it to profitability could fare much better than publicly traded shares where, in a rush to quality, small cap gets annihilated.

But, as long as the investing public stays blissfully unaware of the crippling cocktail being shaken, not stirred, the markets may continue upward in January on rate inspired rallies as Hedge Funds put new money to work. I hope so. Then I will have more time to unload my property, get unencumbered of any debts and find new highs from which to buy my Proshares ETF’s shorting Russell 2000, consumer goods, financials and real estate!

The 1980 gold price discounted for inflation would be above $1,400 an ounce! With this in mind, if the market has its first large correction in an election year and gold is the baby thrown out with the bath water I’ll be selling my shorts and loading up on ETF’s that follow gold, Ivy league Gold Mining companies, International utility ETF’s, agricultural commodities and specific nuclear, solar, water and tech companies. I believe once the bulls have exhausted themselves, cash will be king, gold will be emperor and small cap will be the fool.

America, with it’s vast commodity resources, technological advances and buying power will always prevail but in 2008 I’ll be defensively strapped in to my seatbelt and excited about the next leg up in a downward trending bear market.

When the purging fires come to cleanse the excesses of the biggest housing boom in history, I’ll be ready.

Jen Bawden

Jen is a best-selling author and serial social entrepreneur passionate about disruptive technologies, with a decade of experience in Homeland Security technology solutions. She is also a contributing author at Seeking Alpha, a top financial news site, and a member of several think tanks including: The Aspen Institute, TED, The National Committee on American Foreign Policy, Renaissance Weekend, Summit Series, Task Force on National & Homeland Security, & Secure the Grid Coalition.