For instance, yesterday I bought toothpaste and a thermometer from the neighborhood pharmacy for EUR8. The employee, whom I’ve known for years, asked me how I felt dealing in a hard currency. Although the purpose of his comment was to solicit a laugh, there’s more than a hint of truth behind it.

When I was in Athens almost four months ago, the locals expressed shock over the US dollar’s slump and the state of US economic policy. I encountered similar disbelief throughout northern Europe and the UK during the same trip. No one could understand how the US relinquished its global economic leadership position so quickly.

Still, they hoped the Americans would be able to pull through “as they always do.” See Silk, 19 March 2008, Euro-Thoughts.

Those with vested interests in the US have faith that the US can reclaim its global leadership position in economic guidance and financial prowess and–above all–reestablish the US dollar as the ultimate currency. Keep in mind, however, that the only way the Federal Reserve can defend the greenback is through higher rates, and it isn’t likely to take up such action until 2009.

The outright negativity could be viewed as a contrarian indicator, in which case the US dollar could stage a rally. This is possible. But the issue here is much more fundamental. The US dollar has entered a new era in which it can remain the world’s reserve currency, given the size of the US economy, but from structurally lower levels than the world is accustomed.  

Furthermore, the latest fiasco with Freddie Mac and Fannie Mae hasn’t helped. The world is now watching an establishment in disarray trying to help the common man. But the common taxpayer will be left to fit the bill of his own rescue. Of course, this isn’t such a poor arrangement if you consider the alternative.

The bottom line is that the political-economic establishment is leaning toward the de facto nationalization of the mortgage market, an outcome I’ve anticipated for sometime. See Silk, 12 March 2008, Nationalization. This move is obviously changing the rules of the game. To a certain degree, people aren’t being held responsible for their actions as a socialistic phase of capitalism gradually takes over.

But that’s not necessarily a bad thing; a total disruption of the system won’t help anyone. However, the cancer of “structured finance” will continue to tantalize the so-called Anglo Saxon economies for sometime, even though it’s a dead financial practice. As a result, obscure, well-funded housing lenders with aspirations to become “the next big thing” overnight won’t be resurrected anytime soon, if ever.

Funny enough, I found the following while digging through some old files. I wrote it in early 2005 during my previous life as co-editor of another financial investment advisory publication:

[Our] long-held conviction that the economy can’t sustain rapidly rising interest rates remains intact. The main reason for this is the sheer amount of debt in the system and the average consumer’s undesirable financial situation…if the economy starts showing signs of weakness, then the question begins whether the Fed will continue tightening monetary policy. If it stops and [we] try again to artificially induce growth, then excessive speculation will remain the only game in town, eventually leading to a spectacular collapse of the financial system.

If this is the reality facing leaders in many developed economies, I expect that major emerging economies will be able to withstand the hit much better than before and post decent growth numbers in the face of adversity.

Resource exporters, economies with current account surpluses and relatively healthy banking systems will perform even better as domestic demand remains elevated and the much-anticipated infrastructure upgrade plans remain in place.

Turning to the narrower market picture, the sentiment has grown extremely negative. In fact, in some of my favorite markets, such as Taiwan, investor sentiment is at multiyear lows. And although the market is currently driven by the realization that everything isn’t as rosy as investors were led to believe, it will take a several waves of bullish news for a sharp bounce to emerge.

True, I’ve been expecting some kind of a rally this summer, which hasn’t materialized yet. See Silk, 4 June 2008, Summer Rally. And because we’re halfway through summer, it had better pop up soon.

One key for a late-summer rally will be China’s GDP number, which will be announced tomorrow. I expect data to show a mild slowdown. Investors should have expected a slowdown because the Chinese economy isn’t totally immune to global economic gyrations. On the other hand, investors may act on surprise and lead another selloff.

Every selloff in Asia that reaches the magnitude of the region’s recent action should be viewed as a buying opportunity. The fundamentals remain intact for strong economic growth and market outperformance for years to come.

That said, I don’t advise outright short positions at this time, although shorting in the context of a long-only portfolio is still a game I’m willing to play. Our current short positions in the Consumer Discretionary SPDR (AMEX: XLY) and HSBC Holdings (NYSE: HBC) demonstrate this practice. Both have performed well (up 30 percent and 17 percent, respectively) and should play out even better if the market sentiment deteriorates any further. Lower your stop/loss in HSBC Holdings to 83.

When it comes to the long side, use the Fresh Money Buys as a guide. For details, see Silk, 9 July 2008, The Neo-Bears. You can also add some spice with our frontier market recommendations.

On the latter issue, it’s very encouraging that my recommendation to buy into Vietnam less than a month ago has been very rewarding in such a short time, amid such market turmoil. The Vietnamese market is up 30 percent.

As I’ve said before, I don’t profess to have perfect insight into Vietnam’s downside. But at current levels, the market discounts plenty of bad news. At the same time, the long-term thesis–that Vietnam is a new, important entrant into the global financial order and has plenty of growth potential–remains intact.

The risks are high, but getting some exposure to Vietnam when the markets are weak will prove profitable. Get your exposure through Deutsche Bank’s FTSE Vietnam Index ETF (UK: XFVT). The security trades on the London Stock Exchange and is accessible through most serious brokers. Buy FTSE Vietnam Index ETF at current prices.

The investment process is constant. 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 Portfolio tables for details.

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