Money and Markets

The dollar is falling and doing so at a quickening pace.

It's falling against the euro, the Japanese yen, the Swiss franc, the British pound and even the Brazilian real.

Its decline could have more impact on your financial future than the latest rise in the Dow or the next interest-rate decision by the Fed.

Depending on the choices you make, it has the potential to gut your investment portfolio ... or send it soaring.

This hasn't always been the case. In fact, previous phases of the dollar's fall were mostly ignored by Wall Street, Washington and individual investors.

Now, however, we are entering a critical new phase of the dollar's decline.

In this new phase, not only will the dollar's value fall, but the United States could also suffer a flight of capital.

In this new phase, not only will you see each dollar buy less, but, more importantly, there could be fewer dollars available, as foreign investors slash the flow of dollars from Asia, Europe, and the Middle East ... or even pull their money back out.

This new phase of the dollar decline could ...

• drive U.S. bond prices into a tailspin ...
• drive up the interest rates on long-term bonds, commercial loans and all forms of mortgages ...
• crack open the U.S. housing market -- not only because of rising mortgage rates, but also because fewer foreigners are willing to speculate on American real estate ...
• force the Fed to start a whole new round of interest rate hikes to attract foreign money back to the U.S., and ...
• send contra-dollar investments -- gold, silver, oil and other commodities -- into a new, rip-roaring surge.

This is not merely our forecast of the future. We can see many of the signs right here and now:

Already, the dollar has fallen through key thresholds on the charts, especially against its largest competitor as a world currency -- the euro.

Just a few weeks ago, the euro was worth less than $1.20. Now, its value has jumped to nearly $1.28, as the dollar has fallen. For investors holding U.S. dollars that 7% decline -- in a very short period of time -- makes a noticeably large dent in their portfolio.

Already, the dollar's decline has helped precipitate a parallel decline in U.S. bond prices.

Indeed, most of the dollars held by foreigners are invested in U.S. Treasury securities. So when they're selling dollars, they're also selling bonds, driving down their prices in tandem.

The price of Treasury bond futures was at nearly 115 points in January. Last week, it was down to less than 107.

That's a loss of another 7% on top of the 7% lost on the dollar -- a total loss of 14%, or over ten times any interest earned on the Treasury bonds during the period.

Already, the weaker dollar is lighting a new fire under gold and silver as foreign investors running from U.S. dollar bonds seek safer havens.

Gold was rising steadily even before the dollar began to decline this year.

Now, with the extra buying from international investors fleeing the dollar, it's been going up at an even faster clip ... smashing through the $600 level like a knife through butter ... eclipsing $650 in a heartbeat ... and now making a beeline for $700.

Silver has been even stronger, up by more than 55% just since the beginning of the year. If gold had risen at a similar pace, it would now be close to $800 per ounce.

And soon, you're likely to see the falling dollar drive oil prices sharply higher as well. Remember:

Oil is priced in dollars. So just to maintain the status quo, oil exporting countries must charge more for their oil to offset the lost revenues caused by the dollar's decline. Indeed, of all the markets that rise when the dollar falls, oil and energy are the largest and potentially most powerful.

I repeat: These are not just forecasts. Everything I've just told you about is already happening. And what you've seen so far this year may be just the opening tremors.

Reason: The dollar decline witnessed to date barely begins to reflect the seismic pressures that have been building up for many years ...

Seismic Pressure #1
The Record U.S. Trade Deficit

Right now, the U.S. is importing approximately $800 billion more than it's exporting, the single largest trade gap of any country in the history of civilization.

The reason for the gap is undisputed: Americans have been acquiring foreign goods in a wild, nonstop buying-and-borrowing frenzy. But most foreign consumers have been avoiding U.S. goods like the plague.

The immediate result is also well recognized: Foreign companies have enjoyed huge sales revenues in the United States, collecting equally huge amounts of extra U.S. dollars.

That much is clear. What's still hotly debated is how this gaping deficit is going to impact you!

Will it simply pass you by and let you invest, work, and live as you have been? Or will it begin to impact your money, your job and your entire financial future?

Can you count on your investments holding up and your standard of living continuing to improve? Or should you be worried that you could wake up one morning to a financial earthquake that's off the Richter scale?

If The United States Had Been
Any Other Country on the Planet,
The Answer Would Be Simple:

We would have been forced to pay the price for our trade deficit long ago.

For example, Asian companies collecting dollars from their U.S. sales would have promptly sold them in exchange for yen, won or yuan. European companies would have done the same, cashing them in for euros, pounds, or Swiss francs.

And just as soon as the foreign companies sold their dollars, the value of the dollar would have naturally gone down.

But the United States is not just any country. It is the world's only superpower. And for many years it was the only market large enough to accommodate so much new investment money so fast.

Similarly, the U.S. dollar is not just any currency. It is generally the only one that has served as a currency for the entire world -- often called "the sun around which all the other currencies revolve." As such, it was a staple for any commercial bank, manufacturer, trading company or central bank that wanted a well rounded international portfolio.

So rather than cash in their extra dollars, foreign investors have been sending those dollars back to the United States -- to buy U.S. bonds, U.S. stocks, U.S. real estate, even entire U.S. corporations. That extra buying power, in turn, was what helped prop up the value of the dollar ... and almost every investment in America.

Any other country with a trade deficit as large as ours would have suffered a currency collapse years ago. And with that currency collapse, the value of their stocks, bonds and real estate would have also fallen years ago.

But due to the huge flow of dollars back to the United States, we were spared a similar fate and given an extra lease on the good life. Our money was not gutted. Our economy did not sink into a quagmire.

Instead, our citizens enjoyed the unique privilege of living high on the hog ... without working harder.

Our Congress was given a blank check to spend on wars and pork ... without matching the new spending with new revenues.

Our Treasury Department borrowed from abroad to its heart's content ... without paying higher interest.

As a nation, we got a free ride. We had our cake ... ate it ... and let foreigners pick up the tab.

But as you will see in a moment, it's a devil's pact.

Seismic Pressure #2
Biggest Mountain of
Foreign Debts Ever

After years of record trade deficits and years of selling our assets to foreigners, guess what: Foreign investors now own a big chunk of our stocks and bonds -- approximately two and a half trillion dollars' worth.

They own U.S. Treasury bills, notes and bonds. They own U.S. common and preferred stocks. Plus, they are also big investors in U.S. land, buildings and homes.

Their holdings exceed those of American banks, pension funds, insurance companies, households or any of other single domestic sector.

In sum,

We have been binging. And to finance our habit, we have sold the farm. Dollar by dollar, piece by piece, we have auctioned off our assets to cover the consequences of our seemingly incurable spend-and-borrow addiction.

Seismic pressure #3
Subtle But Powerful
Shifts in Confidence

Now comes the day of reckoning.

There's nothing that requires foreign investors to continue investing in the U.S. or even continue holding U.S. assets they've purchased so far. Like every other investor, every day of every year, they have a choice: To buy, hold, or sell.

They have no obligation to us. Quite to the contrary, it's America that owes an obligation to them:

Anytime foreign investors want their money back, we are committed to returning it to them, no questions asked. Anytime they want to sell, they can do so -- almost instantly.

No, they're not going to sell their entire $2.5 trillion in U.S. securities all at once. But to sink the dollar and shatter our bond markets, they wouldn't have to.

All they'd have to do is make a subtle shift of a few percentage points in how they allocate their investment portfolios: A few percent more for the euro or the yen ... a bit more to gold and oil ... a few percent less for the dollar. That alone would be enough to shake the earth and tear down the walls of the U.S. currency.

What Might Trigger an
International Flight
From U.S. Dollars?

Some of the very same changes we've been telling you about here in Money and Markets week after week:

• Many investors, especially in the Middle East, are likely to be shifting out of dollars as they lose confidence in America's military enterprise in Iraq, and as Iraq sinks ever deeper into the quagmire of civil strife. Back in January, in "Break Points," I showed you how we are about to pass the point of no return in Iraq. Now, even supposedly secure areas are in turmoil, as illustrated by the rising tide of Shiite violence against the British in Basra this past weekend.

• Others could be scared away by the showdown with Iran. Last Monday, in "Winds of War," I showed you how Iran could retaliate against UN sanctions by reducing its oil exports ... paralyzing the Strait of Hormuz ... or worse. Now, just this weekend, Iran has renewed its threats to withdraw from the Nuclear Non-Proliferation Treaty ... its president has just dismissed sanctions as "meaningless" ... and its parliament is pushing to end unannounced nuclear inspections.

• Still other investors are running in reaction to the increasing bravado and defiance they see in anti-American oil countries like Venezuela and Bolivia. In last week's "Time Bombs about to Explode," Larry showed you how and why. Now, Venezuela's Hugo Chaves, Bolivia's Evo Morales, Cuba's Fidel Castro and others are forming an anti-American alliance, again using oil as their primary weapon.

• As Sean vividly illustrated in "Investing for Peak Oil" last week, the fact that worldwide oil production could now be in a long-term cyclical decline is only giving more leverage to all those that might defy the United States.

• And the fact that many of America's high-tech industries -- the last sectors in which the U.S. retained an edge -- could be surpassed by their counterparts in Taiwan, China, South Korea or Japan is not helping either. (See "The Hsinchu Miracle" by Tony Sagami).

• Nor does it help when the new Chairman of the U.S. Federal Reserve -- Ben Bernanke -- sends out signals that he may be soft on inflation, as he did last week. "At the very minimum," say foreign investors, "pay us a higher interest rate to help cover the rising risk we're taking with your dollars." But even that, says Bernanke, is something he may not want to do.

Taken in isolation, does any one of these events seal the dollar's fate? No. But each is opening up another fissure, hastening the day of a major quake.

Clearly, the global reality has changed. Now, the only thing still holding up the U.S. dollar is the lingering global perception of that reality. That's a dangerously vulnerable situation for our currency, for our financial markets and for you.

What To Do

First and foremost, if you still hold long-term bonds, get the heck out! A 10-year Treasury note or 30-year Treasury bond doesn't yield that much more than a 3-month Treasury bill.

So what good is the extra yield over the course of a full year when the principal value of your notes or bonds can fall that much -- or more -- in less than a week?

Second, steer clear of stocks in companies vulnerable to a falling dollar and rising interest rates. That includes most in the banking and housing industry. But a falling dollar actually favors companies that derive most of their revenues from overseas operations.

Third, keep most of your keep-safe funds in 3-month Treasury bills or equivalent. You can buy them directly from the Treasury Department using the Treasury Direct program. Or, for better liquidity and checking privileges, use a money market fund that specializes in U.S. Treasuries.

Fourth, to protect yourself against this new phase of the dollar decline, buy investments that are likely go up when the dollar goes down. You saw how gold, silver and oil are already moving higher. Stick with them and we feel you'll not only have nice hedges against the dollar but also major profit opportunities.

Fifth, for funds you can afford to risk, aim for gains of nearly $70,000 with no risk beyond your modest investment, using Larry's long-term options strategy. Last week, he got the correction he was looking for.

One Last Thought ...

Nearly two thousand years ago, in the year 75 AD, Rome was running a trade deficit of about 100 million sesterces, the equivalent of 2 percent of its total economy. Among the many factors that led to the empire's eventual decline, Rome's trade deficits could easily have been one of the most important.

Similarly, fifty years ago, when I was growing up in Brazil, a massive trade deficit was also a critical factor in that country's decline. Its currency was decimated over and over again.

Just ten years ago, Thailand, Malaysia, Indonesia and other Asian countries were plunged into a currency crisis, thanks to big deficits and over-reliance on foreign capital.

And today, when a country's trade deficit exceeds 5 percent of its GDP, it's a major sign of real and present danger, according to the International Monetary Fund.

But the United States continues to flaunt both history and the IMF. At over 6% of GDP, our deficits greatly exceed those of ancient Rome, 20th century Brazil or any Asian country one decade ago.

Don't take this lightly. Pay close attention to the new phase of the dollar's decline. And take protective action.

Good luck and God bless!