In coming up with a headline for today’s editorial, I was contemplating just using the word “denial.”

Simply put, the investors and markets are in denial…much the same as an alcoholic who thinks that if he skips drinks at breakfast and lunch, he’s okay to drink at night.

As reported here Monday, credit-reporting agency Standard & Poor’s downgraded the U.S. “AAA” credit rating from “stable” to “negative.” It was one big, loud message: if the U.S doesn’t get spending under control, its credit rating will be jeopardized further.

So how did the markets react? They gave us the opposite of what is expected. Instead of the U.S. dollar falling in value, it rallied. Bond prices, instead of declining, rallied. And gold stock prices declined with crude oil prices.

Why would U.S.-dollar denominated assets rally on the news of a U.S. credit rating cut (aside from trying to confuse the heck out of investors)? The reality of the situation is that investors still foolishly flock to U.S. dollars in times of uncertainty—even when the debt rating of the country issuing the dollars, the U.S., has been downgraded.

Back in 2005 I said there would come a time when “real estate” would become a dirty word in America. Few believed me then. Today I’m saying that, as difficult as it may be for us to see, there will come a time in this very generation when U.S. dollars will not be in vogue. A time when any economic uncertainty will see investors running to precious metals, when inflation will run rampant and U.S. dollars will become worth less and less.

Do you really think the politicians in Washington can put a cap on their spending binge? Of course not. In this day and age, spending only what one takes in is a foreign concept to our politicians. It’s utterly ridiculous. Just the interest on the national debt alone costs Washington more than $1.0 billion every day, seven days a week!

Investors are not just in denial; they simply can’t see what’s happening in the economic environment. A government debt ceiling of $20.0 trillion for 2016 may not be enough. QE, Act 3, or a version of it, looks more and more like a certainty to me this summer. What will happen when we get to the point where there are so many U.S. dollars in the financial system that no one wants them? A sobering, but real thought.

The Standard & Poor’s downgrading of the U.S. triple “A” credit rating from “stable” to “negative” is just the tip of the iceberg. Moody’s Investor Service could follow soon with its own rating cut. And the inflation that I’m predicting will take hold over America in the months and years ahead could cause the credit rating agencies to further downgrade the U.S.’s credit rating.

Michael’s Personal Notes:

While the “American Empire” continues to erode rapidly, the new superpower-in-waiting, China, booms.

For the fourth time this year, China has increased the amount of reserves the country’s large banks must maintain. Chinese banks are now required to main 20.5% of deposits in reserve. In other words, big China banks can only lend 79.5% of the money they have on deposit from depositors. Comparatively, during the real estate boom days of 2003 to 2006, it was common for American banks to lend 95% of their deposits out, keeping a reserve of only five percent.

The annual inflation rate in China hit a 32-month high of 5.4% in March. With the U.S. borrowing money like drunkards, China exporting inflation to America, QE3 just around the corner, and the Fed’s printing press running double shifts, how can inflation not become a serious problem in the U.S.?

Where the Market Stands: Where it’s Headed:

The bear market rally in stocks that started in March of 2009 is still presiding. Despite the rally, upside profits from stocks are limited. Rising inflation and rising interest rates are around the corner. We simply await the bear’s final market blow off—the final big rally to suck investors back into stocks.

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 in PROFIT CONFIDENTIAL, March 12, 2007. According to the Dow Jones Retail Index, retail stocks fell 42% from the spring of 2007 through November 2008.

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Tags: china, chinese economy, inflation, price of gold, real estate market, U.S. credit rating, U.S. dollar, U.S. economy