Stephen Roach has been bearish for a while. He believes that the US economy is dangerously strained, and so imbalanced that something has to give.

But, at a private luncheon late in November he told a select audience of fund managers what was really on his mind: “Economic Armageddon”.

Armageddon is defined by the Oxford dictionary as “noun 1 (in the New Testament) the last battle between good and evil before the Day of Judgement. 2 a catastrophic conflict.”

He means it in the second sense: a catastrophic collapse of the US economy.

Roach sees a 30% chance of a slump soon, and a 60% chance that “we'll muddle through for a while and delay the eventual armageddon.” There is only a 1 out of 10 chance that the US economy will remain business as usual.

Why? Partly, because the US continues to borrow heavily, due to its record deficits. It now needs $1.8 billion a day to finance its trade deficit, which consumes 83% of global savings. This is not sustainable, and the rapid decline of the US dollar reflects the world’s concern about this extreme state of affairs.

He notes that household debt is now 85% of the economy, up from only 50% twenty years ago. Americans are already spending a record percentage of disposable income in servicing debt.

Personal savings by Americans dropped to only 0.2% in September 2004, down from 12.5% in 1981. With interest rates expected to rise, most consumers have variable rate debt and will be further squeezed by high financing costs, hurting their capacity to consume and sustain the US economy. Remember, consumer spending accounts for about 70% of US GDP.

If Roach’s prediction comes to pass, there will be virtually no place to hide, globally. The value of real estate, stocks and bonds will be slashed worldwide, and job losses will be staggering.

Gold and other precious metals and equities will be among the very few safe havens.

So, how is investor sentiment in the face of such sobering analysis? A friend of mine in Toronto, who works for Oracle, asked my view on a Chinese on-line gaming company as an investment opportunity.

I liked the company (strong growth, good fundamentals) but hated the valuation (its market capitalization is already three times the expected total revenue for the industry……. in 2008!!).

My friend understood my concerns, but thought it was a good company to invest in for a little while, anyway!

This lack of concern for valuation is totally reminiscent of the Internet bubble era. Valuations did not matter, as long as someone else would come along to pay more for a stock, which was already overpriced or even worthless.

The Directors and Officers of companies making up the NASDAQ 100 seem to think the good times may be ending. In November 2004, they sold $6.6 billion worth of shares, the highest level of selling in more than 4 years.

So it did not surprise me to hear that Mary Meeker was back. Mary, and her peers Henry Blodget Frank Quattrone and Jack Grubman (the last two were banned for life from the securities industry), were superstars: among the most bullish analysts during the Internet bubble days. Mary is now strongly urging investors to invest in NASDAQ stocks, as “this time it is for real”.

Ms. Meeker, who was dubbed the “Queen of the Net” had actually just apologised to her millions of small investors who lost money on her recommendations, before she made her bullish call. In an August 2004 interview with Newsweek, she said "It's not easy for me. People did lose money on the stocks that I recommended and I'm sensitive to that. I wish we would have downgraded them, and I'll have to live with that the rest of my life."

So, here we have two diametrically opposing views: Roach’s pessimistic economic perspective (which portends the decimation of US equities) and Meeker’s bullish exuberance for internet stocks.

Ironically, they both work for Morgan Stanley!

The US dollar has taken a real pounding in the last few weeks.

In remarks prepared for a German conference on the euro in November, Fed Chairman Al Greenspan said it was inevitable that foreign investors will have a "diminished appetite for adding to dollar balances."

This is due to the U.S. current account deficit, which reached a whopping $166.2 billion in the second quarter, on top of record federal deficits.

The natural results of US $ devaluation are rising interest rates (as foreigners need to be incentivised to buy more US $ Treasuries to fund US federal deficits), and inflation. Inflation eases the burden of debt for borrowers by reducing the real value of the debt, and hurts the lenders.

But as the US $ declines, foreign investors already holding US $ assets lose money on their investments. Russia and India have already stated that they will be selling some of their US $ reserves, Japan has said that it will not buy US bonds to support the Yen and if China ever decides to revalue the Remnimbi, the US$ will likely be routed.

Foreign Direct Investment (FDI) into the US is down from $ 314 billion in 2000 to $ 29.8 billion in 2003, down 90%. As the dollar declines further, trends may reverse with net outflows of capital from the US as overseas investors sell to avoid losses.

With the US $ in oversold territory, there is a possibility that there may be a short-term bounce as traders play the currency. But the long-term declining trend seems to be accelerating.

With the ASEAN countries and China announcing last week their plans for a common currency by 2010 and a free trade zone like Europe by 2020, the US faces stiff economic competition and diminishing future demand for its currency.

In an editorial article in the Economist (“The passing of the buck” Dec 2, 2004), the editor writes “Over the next few years it seems an excellent bet that there will be a large drop in the dollar."

The article goes on to observe that the dollar's share of global foreign-exchange reserves has already fallen from 80% in the mid-1970s to around 65% today.

In addition, global foreign-exchange reserves have risen by $1 trillion in just 18 months. The previous addition of $1 trillion to official reserves took a decade. These purchases of dollars have nothing to do with the prospective returns in America, but are aimed at holding down the currencies of the purchasing countries.

Worse still, in recent years capital inflows into America have been financing not productive investment (which would boost future income) but a consumer-spending binge and a growing budget deficit. A current-account deficit that reflects a lack of saving is hardly a sign of strength.

At a BNP Paribas conference in Doha recently the bank’s Global Head of Foreign Exchange Strategy, Hans Redeker, predicted that the dollar would fall probably at a more rapid rate than analysts had predicted.

He also suggested that the pound sterling would drop as “the UK’s manufacturing sector is heading towards recession, the housing market is in steep decline and will take consumer spending with it”

GCC investors, with US $ pegs, are seeing their currencies decline rapidly against the Euro, the Canadian $ and other major currencies.

Investing in the resource sector in Canada is a strategy all investors should seriously consider, as a hedge against the decline in the US $ and due to its positive impact on the price of gold.