— by Michael Lombardi, CFP

Every century or two, one country’s financial and military supremacy makes it a world power. It happened to England, Greece, France, Spain, Italy, Germany and others. Today, the title clearly goes to the United States.

After coming through as the winner of World War II on one side of the Atlantic and the savior on the other side of the Atlantic, the U.S. proved its military strength. After the war, the U.S. economic machine went into full gear, creating the world’s largest economy.

Historians will quote various dates. But roughly a decade to three decades after World War II ended, the central banks of 70% of the world’s countries were so impressed by the American economic machine that they took the American dollar as their reserve currency as opposed to gold bullion.

After the war, the world was buying American goods as fast as they could afford them. Manufacturing in the U.S. was booming. And America, by then an industrial giant, was a creditor nation (which means countries owed the U.S. more money than the U.S. owed other countries).

As silly as it sounds, Wal-Mart started the demise of the U.S. dollar. A fellow by the name of Sam Walton started a discount retail chain that grew beyond his dreams. Seeking to offer Americans the best everyday prices, Wal-Mart not only became the world’s largest retail company, but it also became the largest importer of Asian goods into America for resale. Now Americans were buying more foreign goods than domestic goods, because “homemade” goods became too expensive as American wages rose.

The U.S. government also grew. Through the years, wars in different parts of the world, an aggressive space program, welfare programs, and other expenditures transformed the U.S. from a creditor nation into a debtor nation: the U.S. now owes foreign countries more than it is owed.

Depending on what report you believe, the current economic plague has garnished $12.0 trillion in U.S. government bailouts and promises. And for the first time in my memory, the U.S. is cutting its military spending. History has proven that a country in financial crisis, with rapidly rising debt, eventually sees its currency fall in value compared to other world currencies.

And that brings me to today’s message about the worst kept secret on Wall Street. That secret is the ever increasing debt by which the American dollar is backed. At some point ahead, foreigners, who are the biggest buyers of our debt instruments, will question the value of U.S. dollars. (China is already complaining about its risk.)

I believe the U.S. will need to eventually raise interest rates to keep foreigners interested in the debt instruments we so desperately need to sell in order to finance our debt and annual deficits. If the higher interest rates come before we get out of this economic downturn, it will be devastating.

Michael’s Personal Notes:

If you think this downturn in the economy is hitting only the average person, think again. Sales of yachts are at multi-year lows. In fact, they are being reposed in record numbers from the owners who cannot make the monthly financing payments. Sales for most luxury cars, except for Mercedes, are down significantly. And the foreclosure of Class “A” office buildings in New York City is well underway. The rich are not escaping this one.

Where the Market Stands:

The truth of matter as to where the stock market stands: overvalued. According to bigcharts.com, the Dow Jones Industrial Average sells at 30.74 times earnings, a ridiculously high valuation. After a devastating, fast-acting bear market, stocks became severely oversold on March 9, 2009. Since then, the market has been rallying (known as a bear market rally), but the rally is running out of steam. The saving grace for the Dow Jones is its dividend yield of 3.73%, which is relatively high compared to the present yields on T-bills. The Dow Jones Industrial Average is down 10% for the year.

What He Said:

“There is no mixed signal about this: foreclosures in the U.S. will continue to rise, the real estate market will get weaker, and the U.S. economy will get weaker. Smart investors should seriously consider unloading their stocks of consumer-products companies that produce nonessential goods.” Michael Lombardi, PROFIT CONFIDENTIAL, March 12, 2007. According to the Dow Jones Retail Index, retail stocks fell 42% from the spring of 2007 through November 2008.

Tags: Economic growth, Stock Market News, Today's Profit Confidential, U.S. economy