ATHENS, GREECE–The continued deterioration of the US dollar has left it a laughingstock. Any mention of the US dollar elicits sarcastic comments from simple European folk and deep skepticism from the more sophisticated. And as the last dollar bulls are dragged screaming and shouting into the dollar short trade, you can’t help but think that maybe it’s time for a greenback bounce.

On the other hand, the Fed’s efforts to prevent the credit system from complete obliteration, although admirable, continue to project that the dollar isn’t a priority–allowing investors to question the currency’s real strength. As the dollar continues to deteriorate against the euro, the Japanese yen, and the Swiss franc, many investors wonder if the Fed is loosing control of monetary policy.

It’s also a well-known fact that the US Treasury has a more pro-strong-dollar approach. Although the Fed currently sits in the driver’s seat, everyone else is simply along for the ride without commenting on the driver’s navigational abilities.

At the same time, investors’ confidence in dollar assets is gradually diminishing, especially for assets that aren’t perceived as national champions of shorts. (e.g., Citigroup). The recent Bear Stearns fiasco–in which the second largest underwriter of mortgage-backed debt in the US was unable to secure funding–proved the point. When contracted to help, a lot of the evil Sovereign Wealth Funds (SWF) outright refused. Lehman Brothers, the biggest underwriter of mortgage-backed securities, should be next in line.

European investors I’ve met now believe that, at some point, there will be a huge coordinated intervention to support the US dollar because, if left unchecked, the greenback could totally destabilize the global financial system.

The problem is that no one really knows when this will happen because the dollar continues to weaken after six years of decline. That alone isn’t sufficient evidence. The G7 interfered successfully in support of the greenback in 1985 and 1987, in 1995 for the Japanese yen, and in 2000 for the euro. Sure, they can do it again, but this time it will be a little different.

As the world changes substantially, more countries that may need to give their consent for the success of an intervention of this magnitude. China, the Gulf countries–led by Saudi Arabia–and Russia should also be kept in the loop. Their position in the global economic system is important and will only strengthen as time passes.

The European Central Bank (ECB) will play a major role in such an action because the euro has been the main venting machine for dollar’s weakness. The yen has also started carrying some of the burden, but the euro has been the major carrier for some time.

However, the problem is that the ECB’s priority is fighting inflation– according to its mandate, which a lot of investors have been rather slow to understand. The main point is that the ECB separates its interest-rate policy actions from those of its monetary policy. This is why it’s refrained from slashing rates and has opted for providing liquidity into the system to avoid solvency issues. This policy won’t support short-term growth but will prove to be a notable long-term asset for Europe.

For now, Europe remains focused on the improvement of budget deficits and the like, while growth has become an afterthought. The Eurozone’s budget deficit shrank from 1.5 percent of GDP in 2006 to 0.8 percent last year. Again, this is a good long-term asset but has offset the fiscal efforts of individual countries. France is one example.

But the European economic cycle is also turning down. Italy and Spain are in the forefront of that turn. The former is the more important of the two. Germany, the Netherlands, Belgium and France have remained stronger for longer but should be slowing in the next couple months.

Concurrently, the fast-growing eastern half of the European Union, the so-called “new Europe,” has been running into problems as current account balances deteriorate, with deficits ranging from 5 percent of GDP in the Czech Republic and Hungary to 20-plus percent in places such as Bulgaria and Latvia.

Given their small size and the slowdown phase of the global economy, these excesses won’t work well for these economies and their markets. This is why Russia is the best investment destination in Europe and remains my favorite market this year from a global perspective.

Russia is currently in a sweet spot: It’s a net oil exporter, has good GDP growth, isn’t dependent on foreign capital flows, is politically stable, boasts reasonable market valuations and, above all, enjoys solid exposure to the biggest growth story of our time–Asia. This is why long-term investors should buy the Portfolio’s Russian stocks in every weakness.

The order of preference is as follows: OAO Gazprom (OTC: OGZPY), Mobile TeleSystems (NYSE: MBT), Lukoil (OTC: LUKOY), Vimpel-Communications (NYSE: VIP). See Silk, 19 December 2008, Russia: Top 2008 Market, for my fundamental case on Russian investments.

The reason I’ve gone into length writing about non-Asian issues this week is because the instability that the Western financial system has created is affecting our investments and will help to reshape the future of the global economy much faster than we’ now expecting.

For the short term, though, some of the beliefs I had in the beginning of the year are still valid.

Once again, China and India are expected to carry the burden of [economic] growth, although now the circumstances are more difficult.

The emerging Asia giants may be able to deliver again in terms of economic growth. But the local financial markets are still tied to their developed peers. Global markets have been synchronized for some time now, and it will take years for Asian markets to truly decouple from the US.

Asia has been hit hard this year as expected. (See Silk, 9 January 2008, Difficult Times for Longs.) This remains the year that diversification and hedging will prove extremely useful to the long-only investor. Now is also the time that long-term positions are built at attractive valuations. True, the region can be hit even more; there’s more downside if the global credit crisis spins out of control.

Nevertheless, opportunities are starting to appear, and I’ll be adding some new investments in the Silk portfolios. The selloff may have a longer way to go, but we’ll be able to pick up some strong assets in the process.

For now, notice that South Korea is no longer in the top three spots in the Fresh Money Buys, a position India now occupies. The Indian market has been hit as of late. We were a little early in getting out, and we could hit more turbulence. But now you can buy more in the country’s pharmaceutical sector, which is unloved and underowned. The Silk Portfolio pick is Dr. Reddys Labs (NYSE: RDY).

I’ll be revisiting the India investment story in a future issue because it’s been a favorite of mine for a long time and will gradually become a good place to allocate more funds. As for now, locals are surprised at the thought that the market can turn lower. Remember that the majority of Indian investors don’t know what a bear market is because they haven’t experienced on and don’t seem to be aware of the history of bear markets, although the latter isn’t unique to India.

Nothing has really changed since the last Flash Alert (see Silk, 17 March 2008, Flash Alert: Lower Stop (Again) on China Life Insurance). Stay with the hedge trades.

The investment process is constant. So if you’d like to add to your positions in portfolio recommendations or allocate new funds in a diversified way, focus on the following markets, in order (for both countries and sectors). Consult the portfolios on the left-hand side of your screen for details.

• Russia (energy, telecommunications)
• Hong Kong (banking, real estate, infrastructure)
• India (pharmaceuticals)
• Philippines (telecommunications, real estate)
• South Korea (banking)
• China (consumer, telecommunications, machinery, coal, e-commerce, oil)
• Taiwan (ETF)
• Singapore (banking, telecommunications, industrial)
• Japan (banking, industrials)
• Cambodia (casino/hotels)
• Macau (casino/hotels)
• Europe (communications equipment)