Wither The Dollar

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That is all good stuff, for now. But over the long haul, a banana-republic dollar could lead to inflation, higher interest rates and a recession likely to spill around the planet. In the past, the strong dollar allowed the U.S. government to borrow cheaply and attract investment in the safest currency on the globe. That helped finance the budget deficit, kept interest rates low and also allowed Americans, as individuals and collectively through their government, to spend way beyond their means. Foreigners are big buyers of mortgage securities, which make purchasing that McMansion more affordable. They hold nearly $2 trillion of Treasury securities, keeping government costs low enough to allow the President to consider his new initiatives. But foreigners may be reaching their saturation point when it comes to funding the U.S.'s profligate lifestyle. The nation sucks up 80% of the world's available savings. If the dollar loses its cachet, foreigners will demand higher interest rates, which, if they rise fast or far enough, could topple the economy.

European Pain
Americans traveling in Europe, where their dollars don't go very far, are feeling some pain. While vacationing in Paris last week, university professor Maria Armanda was surprised to find "a bottle of Coca-Cola outside the bus stop was $2.60. That's unheard of! I needed the caffeine, or I wouldn't have bought it." Trina Chang, a Californian backpacking through Europe, says, "We were going to buy two oranges this morning, but they cost so much, we put them back. It's so expensive, it's so sad." More important, the cost of foreign goods in the U.S. is increasing. Consider: at import-foods shop A Southern Season in Chapel Hill, N.C., a pound of European Brie has shot from $6.99 to $8.29 in a year, and even at that price, the store makes less profit. "We try to educate our staff" about the dollar impact so they can explain the prices to angry customers, says manager Briggs Wesche. And it's not just cheese and other luxury imports: every American buys foreign goods, from TVs to food to clothes often without knowing it and many of those things will cost more too.

Hardest hit around the globe are the Europeans, whose exports are being squeezed by the cheap dollar and equally cheap Chinese yuan, which, to the dismay of global leaders, remains pegged at 8.3 yuan to the dollar. China has a large and growing trade surplus with the U.S., and American and European officials argue that the cheap currency gives the Chinese an unfair advantage. Some Europeans are taking advantage of the robust euro to come to the U.S., where everything from iPods to Gap jeans to four-star-hotel stays are suddenly a bargain. (Bookings are up 30% at Germany's largest tour company, TUI, which has been able to cut trip prices as much as 26%.) But euro-land companies are suffering. Exports from Germany to the U.S. are down 10%. Thierry Desmarest, CEO of French oil giant Total, says the dollar's move over the past two years means "we have practically lost one-third of our earnings." Bic, the French firm that makes disposable shavers, says the weak buck has shaved 75% off its sales growth.

Asia's Dollar Horde
Asians are dismayed too, but for different reasons. They are by far the biggest holders of U.S. debt, led by Japan's breathtaking Treasury holdings of $720 billion, followed by China with $174 billion. These sums have been building for years, as Asians, who sell far more goods in the U.S. than the U.S. sells in Asia, have taken their profits and invested in Treasury bonds all of which are losing value as the dollar slips. At this point, Asians have little choice but to hold on and take their lumps, and not just because the large-scale dumping of dollars would crush the value of their remaining holdings. Shifting out of dollars could also be dangerous for the global economy, pushing the beleaguered currency even lower and triggering sharply higher interest rates in the U.S. That in turn would slow the U.S. economy and depress demand for all those imported goods, potentially triggering a worldwide recession.