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Today, we listen to the markets.

The dollar has gone down sharply, but bonds have remained strong. [For complete understanding of the trends weakening the dollar, read Addison's book, which, by the way, makes an unbelievable Christmas present:

Demise of the Dollar

The poor old greenback has dropped 4% against the euro and the yen since October. Now, at $1.33 per euro and nearly $2 per pound sterling, the U.S. currency is at its lowest point in almost two years. For an American, London has gotten even more expensive. But for a Londoner, Florida has become an even greater bargain.

What is the currency market telling us? Maybe nothing. Markets squawk from time to time for no apparent reason. But sometimes they whisper something important.

We listen carefully. We turn our ear. We bend our heads. And what do we hear?

"Beware the falling dollar," says Fortune magazine.

Fortune didn't need to tell us that. What astonishes us about the dollar is not that it loses its value, but that it still has any. The U.S. trade deficit is reaching up towards $1 trillion. No nation has ever run so deeply in the red for so long. For every dollar of output, the country loses about eight cents. For every $100 worth of movies, backhoes, and beef cattle it sells...it spends $108 on flat-screen TVs, oil, and imported sushi. If it were a real business, it would have gone broke long ago.

But the United States is not a business. It is the world's biggest economy...with the world's biggest supply of nuclear weapons. And it is the guarantor of 21st century globalization...and also the provider of its most common means of exchange - the aforementioned U.S. dollar. The U.S. economy, and its money are at the very center of the new imperial cycle that has dominated global markets since the early '90s.

"Yes, but the dollar is the weak link..." the currency markets whisper.

"Foreigners don't have to keep it in their vaults. And they don't have to take it at $1.33 per euro or $650 per ounce of gold."

Ah...that's it, isn't it? The United States can set up puppet governments in third world hellholes; it can whip any conventional military force on the entire planet; but it can't force investors to take dollars at par.

For the moment no one seems particularly concerned about the falling dollar. Ben Bernanke is instead focusing on the threat of inflation, implying that he will raise rates. This, of course, would help support the dollar. Hank Paulson is still talking about the 'strong dollar' policy initiated by Robert Rubin, in whose footsteps he walked at Goldman and now at the U.S. Department of the Treasury.

"Little risk for the United States as the dollar weakens," says a weekend headline in the International Herald Tribune. Most American policy experts see the dollar's decline as a good thing, the paper tells us. It makes Florida vacations less expensive to Europeans, bringing in tourist money.

And it makes GM and Ford products even better bargains; good news for Detroit.

Even Nancy Pelosi, the next Speaker of the House, has nothing bad to say about the falling dollar. In fact, she thinks the dollar should fall - against the Chinese yuan in particular. She believes the yuan is artificially high, thus keeping Chinese imports artificially cheap...and thus making American workers artificially unemployed.

We stop and think. We wonder. What species...what kingdom...what phylum...do these people belong in? Pelosi walks on two legs just like we do, so she must be a vertebrate. She breathes in and out. She is said to be a warm-blooded mammal. But then, what is wrong with her brain?

Every currency in today's magnificent faith-based international monetary system is managed - and it is therefore manipulated by its managers. It is therefore artificial...for nature alone never could have created a piece of paper like the U.S. dollar and set it up to be worth precisely $650 of gold to the ounce. Both the dollar and the yuan were artificially created...and now are artificially valued...by manipulations of all sorts - including central bank lending rates, margin requirements, currency market interventions, capital restrictions, trade barriers and so forth.

Worth $650 today...an ounce of gold could be worth $670 tomorrow; who knows.

All these artificial inventions - combined with the natural movements of the markets themselves, driven as they are by the delusions, misapprehensions, and profound ignorance of investors - are what determine the current price of money. For an economist to say that one is 'too high' or 'too low' is the sort of guesswork the markets laugh at. But when a soon-to-be Speaker of the U.S. House of Representatives says such a thing, it is the gods themselves who must roll on the floor and clutch their stomachs.

We listen carefully to get an opinion from the currency markets. What do they think of the woman? 'She is a moron...' comes the whispered wisdom.

Madam Pelosi's judgment concerns not the 'correct' price of the currency - if there were such a thing. Instead, it is merely a vain wish; she believes the world would be a better place if the yuan were not so cheap.

Why so? Because then U.S. goods would be cheaper for the Chinese to buy...and Chinese goods would be more expensive for Americans to buy. This would have the effect of reducing the U.S./China trade imbalance. But how would people be better off? Every increase in the yuan would turn up as an increase in Wal-Mart's prices. Every Day Low Prices would be a little less low the day after the yuan went up. Who pays these prices? Well, the same people who vote for Nancy Pelosi.

Again, we turn to the currency markets for a judgment:

"Don't worry...the yuan will go up against the dollar...but Americans won't like it very much."

The currency market is telling us that the dollar is going down. Bernanke and Paulson are telling us that the dollar will remain strong. Meanwhile, the bond market is telling us not to pay any attention to Pelosi, Bernanke or the currency market. Bond yields are generally falling. If either inflation or a falling dollar are a genuine threat - bond investors don't see them.

"Forget the falling dollars," say the bond buyers. "What is falling is the U.S. economy."

The bond market may have a point. GDP growth declined from 2.6% in the second quarter to 2.2% in the third. Last week came news of the first setback for manufacturing in the United States in three years. Housing is soft...and getting softer, apparently. And now - thanks to the falling dollar - oil is on the rise again, up 7% in the last two weeks. Gasoline at the pumps is rising. And the yield curve is still inverted - traditionally a good advance indicator of recession.

Under these circumstances, it is unlikely that the Fed can support the dollar with higher interest rates. So, if the dollar continues to fall - look out below!

More news:

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From The Desidooru Saloon...

"The wipeout of a major U.S. bank could easily be one consequence of the explosion in derivatives..."

Read more on The Daily Reckoning's blog:

Derivatives Debacle

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And more views:

*** A note from a friend working the buy side at a hedge fund in NYC...

"I've been hearing more and more about something I hadn't thought that much about before. I assumed that the Fed and Treasury would not take a dollar-negative stance, and instead try to maintain the status quo more or less, but that they would fail. However, I am now hearing from multiple sources (including Saturday's NY Times) that Paulson was brought on to 'manage the decline of the dollar.'

"If that's why Paulson was brought on then that it probably was a motivation behind Bernanke's appointment a few months earlier as well. It looks like the dollar doesn't have any real friends in high places. And I thought I was bearish before..."

James K Galbraith, writing for The Guardian, wonders if the dollar age is lurching toward its end...and decides while it's in no one's best interest to bring the greenback down, it could happen in conjunction with another disaster in our midst: the war in Iraq.

"As the 'Pax Americana' goes to hell in Iraq - producing a nervous breakdown among the pro-war elites - let's remember that security and finance are linked. Typically, the country that provides global economic security enjoys the use of its financial assets in world trade. And when the security situation changes, that privilege can be revoked. The consequences are unpleasant.

"That is partly why Economists for Peace and Security - a group I chair - opposed the Iraq war from the beginning. As far back as 2002, we understood - as the economically illiterate neo-imperialists did not - that a world system very favourable to America was on the line. And it was not, as they seemed to think, just a matter of military might. We knew that if the war undermined confidence in the power, good faith and common sense of the United States, that could lead toward disastrous changes on the financial front.

"Four years in and with no end in sight, that risk may finally be catching up to the almighty dollar."

*** And along the same lines, a dinner companion said on Saturday night, "What is really driving the U.S. economy is the war in Iraq and the war against terror."

"They're spending $75 billion per quarter...that's $300 billion a year.

And it's in addition to the regular budget. People think that money goes to building roads and schools in Iraq. But most of it - all but 15% or so - is spent in the United States. It goes to contractors for computer programs, weapons, and supplies. That has a huge impact on the economy.

And that's why there is so little opposition to the war. People know that when the war stops, the economy goes into recession."

Our friend is a contractor for the Pentagon:

"It is unbelievable how much money is being spent. They are spending billions right on the Pentagon building itself. And now there's a lot of argument about where the money is being spent. People in New York are complaining about spending money in Montana. And they've got a point, of course. Montana is not exactly the front lines in the war against terror.

But from a defensive point of view, almost all the money is wasted anyway, so it probably doesn't make much difference. "

What a strange and wonderful war. Rather than tightening our belts, the war is taken as a pretext to spend more money.

And, one of the biggest advocates of the billion-dollar war is our favorite columnist Thomas Friedman. Of course, the bumbling world improver has pulled the wool over everyone's eyes...Glenn Greenwald, best selling author of How Would a Patriot Act?, wrote:

"...so I spent the day yesterday and today reading every Tom Friedman column beginning in mid-2002 through the present regarding Iraq. That body of work is extraordinary. Friedman is truly one of the most frivolous, dishonest, and morally bankrupt public intellectuals burdening this country. Yet he is, of course, still today, one of the most universally revered figures around, despite - amazingly enough, I think it's more accurate to say "because of" - his advocacy of the invasion of Iraq, likely the greatest strategic foreign policy disaster in America's history...."

[Ed. Note: To read the rest of Mr. Greenwald's musings on this subject, see here:

Unclaimed Territory

*** The German's exports equal 40% of their economy. For Austria, Belgium, the Netherlands, and Ireland, exports are half of GDP. All these countries are benefiting from globalization.

The United States, on the other hand, has been a victim of its own good fortune. It can export money. America has the world's reserve currency...which put it in much the same position as Spain in the 16th century. Gold, then, was the world's reserve currency. And Spain had gold.

She had stolen it from the Aztecs and Incas, fair and square. And when she brought it back to the Old World, she found herself immensely rich.

What happened next, you might wonder? Well, we'll tell you...

Two things...

First, this extra gold represented a huge increase in the money supply.

Naturally, prices rose. Consumer price inflation soon became a major fact of life throughout Europe - but especially in Spain.

Second, the Spanish found that they could buy what they needed from abroad. They had money, so they didn't need to develop domestic manufacturers. Neglecting their own business and commerce, the Spanish lived on imports. We don't have the figures, but the circumstances imply a huge trade deficit between Spain and the rest of Europe during the 1500s.

Goods and services came to Spain...and gold left her.

By mid-century, Spain was already in decline. Her gold had run out. All she had left was military power. So she put together her 'Invincible Armada' to attack England. As we all know, the armada soon proved vincible...and Spain retired to second-rate...then third-rate status and remained there for centuries. As recently as the 1970s, people in France said: "Africa starts at the Pyrenees."

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The Daily Reckoning PRESENTS: The fall of the dollar is like a car accident...you want to cover your eyes and walk away, but you can't help but watch it with a sense of amazement. And if you look through the history of currencies, you'll find that all printed money eventually ended up the same way: practically worthless. Addison Wiggin explores...

THE DISMAL HISTORY OF PHONY MONEY

by Addison Wiggin

History has shown that money - not counterfeit, but official money printed by the government - has been known to lose value and become virtually worthless. Examples include Russian rubles from pre-Revolution days, 50-million marks from 1920s Germany, and Cuban pesos from pre-Castro days.

In all of these cases, jarring political and economic change destroyed currency values - suddenly, completely, and permanently.

What kinds of events could do the same thing to the U.S. dollar, and what can you do today to position yourself strategically? The potential fall of the dollar is good news if you know what steps to take today. We're not as insulated as many Americans believe. In the 1930s, 20 percent of all U.S. banks went broke and 15 percent of life savings went up in smoke. After the emergency measures put into effect by President Franklin D. Roosevelt through the Emergency Banking Relief Act of 1933, confidence was restored with another piece of legislation: the 1933 Glass-Steagall Act. This bill created the Federal Deposit Insurance Corporation (FDIC), insuring all U.S. bank deposits against loss.

The severity of the growing situation had been seen well in advance. The financial newspaper Barron's, established in 1921, editorialized in 1933 that: "Since early December, Washington had known that a major banking and financial crisis was probably inevitable. It was merely a question of where the first break would come and the manner of its coming."

Two weeks earlier, the same column cautioned its readers that when the dollar begins to lose value, this leads to a series of "flights" - from property into bank deposits, then from deposits into currency, and finally from currency into gold.

We can apply these astute observations from 1933 to today's currency situation. The government, anticipating a flight from currency into gold, had already made hoarding gold or even owning it illegal. The second step

- insuring accounts in federal banks - helped to calm down the mood. By preventing the panic, currency stabilized. But in those times, we were still on the gold standard. The currency in circulation was, in fact, backed by something. Remember, that riverboat gambler who keeps asking for ever-higher markers will eventually run out of credit. At some point the casino boss realizes that his ability to repay is questionable. Maybe those markers are just a heap of IOUs that can never be cashed in.

In the 1930s, the causes of the Great Depression were complex but related to a series of obvious abuses in monetary, financial, and banking policies. History has simplified the issue by blaming the Depression on the stock market crash (which takes us back to the explanation that "wet sidewalks cause rain"). The stock market crash, one of many symptoms of policies run amok, has lessons for modern times. The unbridled printing of money - expansion of the "IOU economy" - is good news for those who recognize the potential for gold.

We hear experts on TV and in the print media shrugging off the deficit problems. "Our economy is strong and getting stronger" is the mantra of those with a vested interest in keeping dollars flowing: Wall Street brokers and analysts, for example. But we cannot ignore the facts. The federal deficit is growing by more than $40 billion per month. It is not realistic to point to this economy and say it's doing just fine.

Gold is the beneficiary of reckless monetary policies and the War on Terror. Check the average value of an ounce of gold over the past decade.

It has been rising steadily since the end of 2001. The cause of this change in gold's price may be attributed at least partly to the attack on the World Trade Center. But it reflects equally on the Fed's monetary policies and spiraling debt-based economic recovery. During the same period that gold prices have begun to rise, we should also take a look at the trend in money in circulation.

This is troubling for the dollar but - again - great news for gold.

Remember what the world economic and political situation was like in the early 1970s: a weakening dollar, easy money, and international unrest.

Sound familiar? We're back in the same combination of circumstances that were present when gold prices went from $35 to over $800 per ounce.

The numbers prove that gold is going to be the investment of the future.

World mining in gold averages 80 million ounces per year, but demand has been running at 110 million ounces. So if central banks want to hold the value of gold steady, at least 30 million ounces per year must be sold into the market. This creates a squeeze. As the dollar weakens, central banks will want to increase their holdings in gold bullion, not sell it off.

This is why gold's price has started to rise and must continue to rise into the future. As long as that demand grows - and it will rise as the dollar's value continues falling - the price of gold simply has to reflect the forces of supply and demand.

But, you might ask, why do central banks want to hold down the value of gold? We have to recognize how this whole money game works. Most world currencies are off the gold standard, following the U.S. example. So as gold's value rises, it competes with each country's currency. Of course, the trend toward weakening currencies and the continuing demand for gold mean that the growth in gold's value could continue strongly for many years to come.

When the United States removed its currency from the gold standard, it seemed to make economic sense at the time. President Nixon saw this as the solution to a range of economic problems and, combined with wage and price freezes, printing as much money as desired looked like a good idea.

Unfortunately, most of the world's currencies followed suit. The world economy now runs primarily on a fiat money system.

Fiat money is so-called because it is not backed by any tangible asset such as gold, silver, or even seashells. The issuing government has decreed by fiat that "this money is a legal exchange medium, and it is worth what we say." So lacking a gold backing or backing of some other precious metal, what gives the currency value? Is there a special reserve somewhere? No. Some economists have tried to explain away the problems of fiat money by pointing to the vast wealth of the United States in terms of productivity, natural resources, and land. But even if those assets are counted, they're not liquid. They're not part of the system of exchange.

We have to deal with the fact that fiat money holds its value only as long as the people using that money continue to believe it has value - and as long as they continue to find people who will accept the currency in exchange for goods and services. The value of fiat money relies on confidence and expectation. So as we continue to increase twin deficit bubbles and as long as consumer debt keeps rising, our fiat money will eventually lose value. Gold, in comparison, has tangible value based on real market forces of supply and demand.

The short-term effect of converting from the gold standard to fiat money has been widespread prosperity. So the overall impression is that U.S. monetary policy has created and sustained this prosperity.

Why abandon the dollar when times are so good? This is where the great monetary trap is found. If we study the many economic bubbles in effect today, we know we eventually have to face up to the excesses, and that a big correction will occur. That means the dollar will fall and gold's value will rise as a direct result.

The sad lesson of economic history will be that when the gold standard is abandoned, and when governments can print too much money, they will. That tendency is a disaster for any economic system, because excess money in circulation (too much debt, in other words) only encourages consumer behavior mirroring that policy.

Thus, we find ourselves in record-high levels of credit card debt, refinanced mortgages, and personal bankruptcies - all connected to that supposed prosperity based on printing far too much currency: the fiat system.

We can see where this overprinting will lead. As debt grows relative to gross domestic product (GDP), we would expect to see positive signs elsewhere, such as a growth in new jobs. But like a Tiananmen Square Rolex watch deal, the value simply isn't there. Job growth is slow but, in reality, there is a decline in earnings. High paying manufacturing jobs have been replaced and exceeded by low-paying retail and health care sector jobs, so even if more people are at work, real earnings are down.

Instead of simply measuring the number of jobs, an honest tracking system would also compare average wages and salaries in those jobs. Then we would be able to see what is really going on - more low-paying jobs being created, replacing high-paying jobs being lost.

Addison Wiggin

The Daily Reckoning

Editor's Note: Addison Wiggin is the editorial director and publisher of The Daily Reckoning. Mr. Wiggin is also the author, with Bill Bonner, of the international bestseller Financial Reckoning Day and the upcoming thriller Empire of Debt. Mr. Wiggin is frequent guest on national radio and television programs.

The above essay was taken from Mr. Wiggin's newly-released book, The Demise of the Dollar...and Why It's Great for Your Investments. To order your copy, please see here:

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