Since whispers of a Lehman Bros collapse started to circulate almost two weeks ago the US dollar index has slumped 4.8%. And the $700 billion Paulson bailout plan has done little to shore up dollar strength.

There are “fears that the package may cost too much, drive up inflation, swell the already bloated U.S. deficit and hurt the ailing economy,” reports AP.

Eric Fry says his investment strategy is based on a simple formula: “Sell the dollar, sell the dollar and sell the dollar.” And as the buck gets whacked, so will American stocks and bonds. On the other hand, foreign assets and commodities should soar…

This from The Rude Awakening:

During the last couple of years, I have been very afraid of the stock market, and in particular I have been afraid of the financial sector. So in many, many editions of the Rude Awakening, we’ve been telling our readers just to hide as well as they can.  Mostly we have been telling them to hide out in commodities like gold and oil, and also to hide out in investments that are denominated in any currency other than the US dollar.  For the most part, these have been very good hiding places. But lately, these hiding places are starting to feel a bit like tombs. The commodity markets have been horrible.

Stocks and commodities usually move in opposite directions. But during the recent stock market selloff of late August and early September, commodities provided almost no protection whatsoever. In fact, they performed even worse than stocks.

Therefore, many of us resource investors are feeling more chagrin than satisfaction. We sidestepped the financial sector 18-wheeler, only to step in front of the commodity sector bus. But at least we’re still flinching on the pavement…unlike our bank-stock-investing counterparts. We should remember that Merrill Lynch (NYSE:MER) stock has delivered a total return of MINUS 45% during the last 10 years! Commodity prices have nearly doubled over the same timeframe. So all of us commodity investor who gravitate toward self-flagellation might want swing the whip a little more gently. These are very unusual times in the financial markets.

Even though commodity prices have retreated substantially from their all-time highs, they will rebound eventually…and then continue on to new all-time highs. (Perhaps the big bounce in gold and oil during the last couple of trading sessions is the start of something bigger). So at the risk of repeating myself, I will repeat myself anyway: I like commodities, at least for the long haul, if not also for the short haul. I like commodities because supplies are limited and demand is not. I also like commodities because they lack CEOs and executive management teams. I like commodities because greed and stupidity cannot destroy their value.

Please understand that my opinions are just that, mere opinions.  I’m not issuing any prophecies here, just a couple of guesses. And even my guesses aren’t really guesses at all; they are reactions to fear.  I am afraid that the US Federal Reserve and the U.S. Treasury have overextended themselves.  They have committed hundreds of billions of dollars to rescuing Bear Stearns, Fannie Mae (NYSE:FNM), Freddie Mac (NYSE:FRE) and AIG etc.  That’s bad enough.

What’s worse is that these governmental agencies have exposed themselves to more than $1 trillion of potential liabilities.  No one knows how large the ultimate invoice will be to clean up the American financial system.  But we investors can assume that much of the money to satisfy that invoice will roll off of printing presses.  We can assume, in other words, that the Treasury will greatly inflate the money supply in order to prevent an even more extreme credit crisis.  This process will almost certainly erode the dollar’s value.

And so we ask ourselves, “What wins when the dollar loses?” Gold, the currency of the ages, comes to mind immediately.  But we would also expect most other commodities to perform extremely well in a weak-dollar environment.  And obviously, investments that are denominated in a foreign currency should perform relatively well when the dollar weakens, at least from the perspective of an American investor.

Also, we should expect the Treasury’s multi-billion-dollar bailout packages to increase the supply of Treasury bonds. I’m not so sure these bonds will meet with eager investment demand. For one thing, whenever supply swamps demand, prices fall.  That’s economics 101.  For another thing, the traditional buyers of Treasury bonds might become much less eager to loan money to a government that is buried under a massive mound of unknown and growing liabilities. So I’m afraid the road in front of us will be very difficult for investors in American stocks and bonds.

Investors who wish to bet on falling Treasury bond prices could buy an ETF like the UltraShort Lehman 20+ Year Treasury ProShares. (AMEX: TBT; Price $68.37) This unique ETF wins when Treasury bond prices fall. Specifically, this ETF produces an investment result that corresponds to 200% of the inverse of the daily performance of the Lehman Brothers 20+ Year Treasury Index.

I think we’ve reached an important inflexion point in the American financial markets. The extinction of Bear Stearns, Lehman Bros., Fannie Mae and Freddie Mac - along with the near-death experiences of AIG, Merrill Lynch, Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) - tell us that a very important change has occurred in the financial markets. The extreme greed and institutionalized speculation that has nourished the Wall Street brokerage firms for so many years has finally been exposed as the fraud it has always been.

American-style investment banking is not a “business model,” it is a Ponzi scheme - a fraud - in which all the money flows to the people at the top, while everyone else who plays the game absorbs the losses. This massive institutionalized fraud is now over.

But investors must understand that this fraud created enormous leverage in the financial system.  And this enormous leverage created enormous liquidity which caused stock prices all around the world to soar… and therefore, caused lots of investors to feel rich and happy.  But now that all of this leverage is collapsing, the liquidity it created is draining from the financial system and causing share prices to fall sharply.  The U.S. Treasury and the Federal Reserve are trying very hard to counteract these trends by absorbing hundreds of billions of dollars worth of bad mortgages, and also pumping fresh credit into the banking system.

The Treasury and the Federal hope that these actions will restore buoyancy to the potential markets.  But we doubt it.  Instead, we suspect that these actions will only add buoyancy to the US inflation rate and, therefore, to commodity prices.

Most of the bad guys who created this mess are gone…although not yet in prison where they belong. And most of the American regulatory agencies are eager to change the rules of the game. These two developments are very helpful. But the process of repairing and reforming the American financial system could be painful. The U.S. Treasury will absolutely, positively increase the money supply to rescue the financial system…Which means investors must try to protect themselves against an almost certain inflation.

So what’s an investor to do?

Sell American stocks, bonds and currencies; buy foreign stocks, bonds and currencies. And, of course, buy commodities.

Source: To France with Love