Top Stocks Market: The Dollar Dike Gives Way?

"China stuck in dollar trap," says the headline on the front page of the Financial Times.

The FT says China is buying more U.S. bonds than ever. It must...according to the news report...because it has too many. Unless it supports the dollar, it risks a big collapse in the value of its foreign exchange holdings (mostly in dollars).

China has its finger in the dike. But it may need a bigger finger. This morning it is trading at $1.40 per euro - a new low for the year. Measured against gold, it now takes 958 dollars to buy a single ounce of gold.

"We have a huge amount of money in the United States," said Wen Jiabao, premier of the People's Republic of China, back in March. "I request the U.S. to maintain its good credit, to honor its promise and to guarantee the safety of China's assets."

In response to this request, U.S. Secretary of the Treasury, Timothy Geithner, answered in the positive. Whether he had his fingers crossed behind his back, or not, we do not know. But for the moment, the United States is honoring its promises in the short run...but doing so in such a way that dooms the Chinese in the long run.

Now, the Fed is buying U.S. Treasury bonds. So are the Chinese. Supporting each other, they are also supporting prices of bonds - which happen to be the largest single source of financing for the U.S. government and the largest single liquid asset of the Chinese government. Despite the support of the biggest investors in the world, the price of bonds and the price of the dollar both sank last week. Which makes us wonder: what happens when both the United States and China turn into sellers?

That may not happen soon. But it will happen.

For now, the United States has to sell trillions more in bonds to finance its imperial ambitions, bailouts and boondoggles. The Fed will have to buy them...along with the Chinese. If top stocks market fall - as we expect - they are likely to be joined by many other buyers too - all seeking safe haven in the world's leading credit.

But at some point, as always, what must happen will happen. Not forever can the United States spend $2 for every dollar it receives in tax revenues. Not forever can the Chinese support the value of a bad investment, in which they are already too heavily invested, by buying more of it. Not forever can the dollar hold its value when the Fed is busy creating hundreds of billions more of them. And not forever can the Fed continue to inflate the currency when the dollar is falling.

Since the Fed inflates by buying bonds, when consumer price inflation begins to menace the bond market, it must deflate by selling them. When that moment approaches, even if it is months or years ahead, Daily Reckoning readers are warned: that will be a bad time to be visiting China...and a bad time to be holding U.S. Treasury bonds...and a bad time to be standing behind the dike. Make sure you are fully prepared - get your dollar crash insurance here.

Meanwhile, the International Herald Tribune says that Latvia is being crushed under a huge government deficit. Formerly middle-class citizens are out of food, says the paper. Further down on the socio-economic ladder are scenes of "Dickensian misery."

What provoked this horror, according the IHT, is a current budget deficit equal to 12% of GDP.

Wait! The US budget deficit is 13% of GDP. Sooner or later, that deficit will crush Americans too...

On Saturday, we gathered with the family - what is left of it - in Southern Maryland. A cousin took us on a little tour and kept up a lively monologue:

"Yeah...things have changed around here. But not necessarily as you would expect.

"My business is doing so well I can barely keep up with it. Of course, that's because the state decided to protect the Chesapeake Bay by paying people to put in new septic tanks. They've got a new device that is supposed to aerate the water in the tank to that it puts out less nitrogen. It looks like it should cost about $100...so the state pays about $2,000 for it. And then, they'll pay the entire cost of replacing the old septic tanks. My guess is that it does very little good. But I'm putting in these new tanks all over the place...

"Housing speculators are getting hurt...but we haven't seen any major bankruptcies.

"When the stocks market of 2010 was hot they were putting up these huge boxes," he continued...pointing to a group of what looked like brick McMansions. "They just staked out the lots and plopped these monster houses down on them and sold them for $1.2 million each. These houses are huge...7,000...8,000 square feet...but they have no charm at all. Just big brick boxes with plastic windows. No view. No gardens. No trees to speak of...

"This fellow here built a 10,000 square foot house...look at it. It's meant to look like an English manor house, I guess. It's even got a little cupola on the roof...I think you can go up into it. I know the fellow so I went over and he gave me a tour of it. Every time we came to a window he said 'look at that view...' There's a beautiful horse farm in the distance. But between the horse farm and his house there are these huge power lines. So, when I looked out the window all I saw was the power lines.

"He was trying to sell the place for $4 million. I doubt if he'll get $1 million for it now."

We drove up to Parole, an out-cropping from Annapolis. It got the name during the Civil War when it was the site of a Union prison camp.

"And look what they've done to this...it used to be a shopping mall...but that went out of business when they built the new mall down the road, so they developed this into upscale apartments with shopping beneath them. I think they sold about half of them before the bottom fell out of the top stocks market for 2010."

Near the apartments was an immense Fresh Fields store. It was the first time your editor had ever seen the inside of one. The array of food - all of it very well presented - was staggering. We had never seen so many varieties of things we didn't even know existed. Shoppers are said to be scaling back and moving down-market. They're supposed to be giving up Fresh Fields and going to the Safeway. But we saw no obvious signs of it. There were hundreds of shoppers. Still, the cost of laying out so much food, much of which must go to waste, is probably as staggering as the display. There were dozens of clerks in red frocks. And thousands of square feet of space. The whole thing seemed like a relic of the Bubble Époque.

"Let's go back down the road," our cousin continued. "Let's go look at the old family farm...and we'll stop in and take a look at the Lansdowne place too. Old John died a couple years ago. The house was empty. Then it burned down. Too bad. That house had been there for more than 200 years. You know, John had spent his career in the army. He must have moved around a lot. And he had five daughters. I guess the daughters never got attached to the place, because when John died none of them wanted it. Kind of sad...because it had been in the same family since the Revolution and it's a wonderful farm."

We drove in the driveway...past a sign that said 'No Trespassing Any Time'...then down a long gravel road lined by old oak trees. Finally, we came to the house site. There was nothing there but a patch of brown dirt with a few broken bricks...where the ruins had been bulldozed to the ground. As we stood there...looking at the bits of brick and tableware...and then down the lawn...the sweet smells of the locust trees in bloom were intoxicating.

"What a great place for a house. It looks down the hill and then through the gate down the long driveway with those old trees. Makes me kind of sad every time I come here. More than two centuries of family history...and there's nothing left of it...just these cinders in the dirt. Those girls have all left the area. I'm just glad John was already dead. Maybe he won't know..."

Later, we drove to our own farm. There, we saw signs of neglect. Trees need to be pruned. Fences need to be repaired. Shutters need to be built. Even when it is under the eaves and painted, wood seems to rot.

"It's not the same wood they used to use," our cousin explained. "They used to use heartwood of oak. Now, all you get is pine. Get it wet, even a little bit wet, and it will soon be punky.

"Things are always going wrong. I was just thinking of John. He must have kept having children, hoping to have a boy who'd want to keep the farm...and every time he got another girl.

"Then, those poor developers...they probably knew the end of the boom was coming...but they kept building...hoping to get things old before the boom ended.

"And then, it seems there are always family problems. You know Dennis? He took over the family's construction company. The other boys became accountants or lawyers...or something. It's always a story of the outsiders against the insiders. Dennis ran the business. But the other brothers wanted money from it. And Dennis is having a hard time now that people aren't building so much. So when the time came to renew the lease on the headquarters building all hell broke loose. The brothers who weren't in the business thought Dennis was living too high on the hog. I don't know about that. He was always driving around in that old company pick-up truck every time I saw him. But the brothers wanted a lot more rent; the building...and the land is still owned by the family. Dennis only had a lease on it. But Dennis got mad and moved out. He took the whole company and rented a space across town. Now, the family's got an empty building and no rent.

"This has nothing to do with it, I guess it's just another story about things going wrong...but remember Paul Holland? He and Mimi were getting ready to celebrate their 50th wedding anniversary. As far as we knew they were happy together. They had children and grandchildren. But then, just before their 50th anniversary, Paul said he had fallen in love with a much younger woman and moved out. Of course, Mimi was floored.

"Can you imagine that? He must have thought it was his last chance for love. But you wonder what had he been doing...thinking...all those years? He's over 70...and now, he's starting out all over again. I can't imagine it. Much too much trouble...

"Reminds me of a story...about a conversation that took a bad turn.

"A man and his wife were preparing their wills... The woman asks her husband if he would get married again, if she died first.

"'No, I wouldn't want to marry again,' he said.

"'Well, why not?' she answered. 'Don't you like being married?'

"'Well...yes...'

"'Then why wouldn't you want to get remarried?'

"'Well...okay...maybe I would get remarried.'

"'But where would you live...would you bring your new wife to our house?'

"'I guess so...it's a nice house...I wouldn't want to move.'

"'You mean...you'd let her drive my car and sleep in my bed?'

"'I don't know...I hadn't thought about it...but, yes...I guess so...why not?'

"'And I suppose you'd even let her use my golf clubs?'

"'Oh no, I wouldn't do that. She's left handed.'"