On the surface, the economy seems to be doing well. The stock market continues to rise, as corporate earnings have surprised all year long on the upside, interest rates remain at historically low levels and Quantitative Easing Part II is on its way. Aside from those caught in the U.S. housing mess, consumer confidence is inching towards the positive once more. It will be the best Christmas season for retailers in three years.

PROFIT CONFIDENTIAL readers have fared well in 2010, as our number one investment pick for the year, gold, keeps rising in price. As I write this morning, gold bullion is up 24.7% for 2010. More importantly, many of the gold stocks we recommended this year have performed exceptionally well, with many such stocks doubling in 2010.

So what keeps me awake at night? What’s that big fear for the economy I have that lurks in the back of my mind?

My concern is the ramification for the economy of the U.S. dollar continuing its collapse against other world currencies. Since 2002, the greenback has lost 37% of its value against other major world currencies. We are very, very close to breaking below record low levels for the U.S. dollar vs. a basket of the world’s most popular currencies.

So what does that mean to consumers, investors and the economy?

For the most part, the decline in the value of the U.S. dollar up until now has been positive for America. The lower our dollar goes, the better it is for our manufacturers that export abroad, the cheaper the debt that we have issued becomes, the more people there are traveling in the United States. Bottom line: it is a good thing.

However, the risk arises when our dollar gets so low — or continues its free-fall in price — that foreign investors start to fear their investments in the U.S. Treasuries our government issues to fund our debt. That’s when our domestic interest rates start to rise. The debt we issue every day to fund the government operations is mainly purchased by foreign investors. China alone is sitting on trillions of U.S. dollars, which it uses to buy U.S. Treasuries.

But what happens if our dollar falls another 10%, 20% or 30%? What will happen is that foreigners will become less willing to fund our debt. Our interest rates will need to rise and that will close the coffin on this ever-fragile economy.

And when my subscribers read that I believe the stock market lows of March 2009 will eventually be tested, this concern explains it.

We must face the facts. At this point, our government is upside down by about $125 billion dollars per month. It takes in $125 billion less per month than it spends and the politicians have done nothing significant to curb this excessiveness.

If the U.S. government were a consumer or business, it would be broke long ago.

Rising debt is the main cause of weakness for the greenback. What currency rises in price when the government issuing and standing behind the currency is broke?

This is what I worry most about. A currency so sick that gold rises 25% against it in less than 10 months. A U.S. government spending $1.4 trillion to $1.5 trillion a year more than it takes in. A collapsing currency that could cause domestic interest rates to rise sharply if the debt spiral behind the currency does not come under control soon.

Where the Market Stands:

The Dow Jones Industrial Average opens this morning up 6.1% for 2010. Add in a dividend yield of 2.6% and we’re not far from a 10% return for stocks this year.

What’s fueling the slow rise up the “wall of worry” for stocks? If I had to pick the main factor, it would be the easy monetary policy that prevails. Interest rates remain at record-low levels and the Federal Reserve is ready to jump in with Quantitative Easing Part II. Aside from gold, investors do not have much choice for parking their cash. The yields on bonds have just become too low.

I’ve been bullish on corporate earnings for most of 2011. And earnings have surprised on the upside. Just this morning, Citigroup Inc. (C/NYSE) reported that it made $2.17 billion in the third quarter, up from only 101 million dollars in the same period of 2009. The bank, which is 12%-owned by the U.S. government, easily beat analyst earnings expectations.

My feeling is that the bear market rally that started in March 2009 remains intact.

What He Said:

“Bonds could now be a buy: Bonds rise in price when interest rates fall as their return makes them more valuable. After a bear market in bonds that has lasted for months, the action in the bond market, as I read it, indicates that the bear market in bonds could be over. I’ve always preferred quality when buying bonds, going with government bonds over corporate bonds. If you have some cash lying around, bonds could be a great deal.” Michael Lombardi in PROFIT CONFIDENTIAL, July 24, 2006. Government bonds were one of the best performing investments from mid-2006 to late 2008, as they rose in price sharply when the Federal Reserve reduced interest rates to one percent in October 2008.

Tags: stock analysis, Stock Market Analysis, U.S. Treasuries, US debt, US dollar, us economy