The dollar fell to $1.42 per euro yesterday. Many believe it is the Achilles’ heel of the entire world financial system – and Warren Buffett is among them.

The story goes, Achilles was dipped in the river Styx and made invulnerable. But his mother held him by his heel, leaving that part untouched by the magic waters. Naturally, that is where a poison arrow got him.

The moral of this story is that you have to go all the way. If you want your baby to be invulnerable, put him all the way under the water…even the heels. Or, maybe there’s another point: that there’s always some place where you’re vulnerable.

For the purpose of today’s tale, we’ll take the second possibility. Try as you may, you can never escape all risks.

All over the world, consumer prices are falling. The world has too much capacity…too many factories…and too many workers. Too many, that is, for current demand. The ‘world’s mouth’ – the USA – has gone on a diet. And if the United States reduces its intake, that means the rest of the world – especially China – must reduce its output. Otherwise, the whole thing will become unbalanced.

Yesterday’s news tells us that despite press reports of a recovery, the key indicators of real economic growth are still falling. Almost one out of ten mortgages are now delinquent. And the rate of foreclosures is increasing faster than any time in the last 30 years. Housing prices, meanwhile, fell 16% in the 2nd quarter, from a year earlier, according to the National Association of Realtors.

Unemployment claims went up last week. The sharp eyes of The Financial Times see the link: “Mounting joblessness fuels US housing crisis,” says its headline.

In the real economy, people are cutting back…with the inevitable results we discuss every day here in The Daily Reckoning. One major consequence of reduced demand is too much supply. The factories built in China to supply products to America during the bubble years now find they have no market.

Currently, overcapacity and oversupply are causing prices to fall. Falling prices mean rising currency values. Each unit of ‘money’ buys more stuff. But there are many competing currencies, and they don’t all rise and fall together. Even in a world of deflation, some currencies will deflate more than others.

The dollar is, of course, the world’s main money. In a sense, the whole world economy is under its heel. But it is a heel that has never been dipped in the river Styx. It is now a heel that waits for an arrow.

PIMCO is the biggest manager of bond funds in the world. It says the greenback is going to lose its status and lose its value.

“Investors should consider whether it makes sense to take advantage of any periods of US dollar strength to diversify their currency exposure,” says its Emerging Markets Watch report. “The massive amounts of US dollar liquidity produced in response to the crisis” doom the currency.

Both China and Russia are calling for a new global currency to replace the dollar.

“While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the US dollar as a store of value even in the absence of a single viable alternative,” continues the PIMCO report.

Meanwhile, our old friend Jim Rogers says he is moving all his assets out of dollars and buying Chinese yuan. And Warren Buffett warned this week – writing in The New York Times – that “greenback emissions” threaten the whole world econo-system.

But what does it mean? What are the threats to you? What are the opportunities? If you pay your bills and keep score in dollars, what does it matter if the dollar loses value against the yuan? If prices are generally falling, the dollar is actually getting stronger, isn’t it? So what if some other currencies are getting even stronger still?

Colleague Bill Jenkins, at Master FX Options Trader puts in his two cents:

“We lived through a financial earthquake in 2008. The effects of it are still being felt. Aftershocks may still be ahead. But predicting when they’ll strike is just as hard as predicting natural earthquakes. We had a number of prognosticators for years telling us about what would happen last year; it’s just that they didn’t know when. And that is the hard part of the life of a prophet.

“And while it is equally difficult to tell when the next economic tremors will hit, we can look at the numbers and make some predictions as to their cataclysmic effect.”

Bill goes on to say that he thinks the US is headed for another shockwave…which will include another round of dollar buying – even while the ‘experts’ are touting ‘green shoots’ and a return to normalization.

The trouble with the Achilles’ heel is that it is connected to the Achilles’ tendon…which is connected to the leg muscles…which is what keeps the whole thing moving forward. Cut the tendons and the feet go flippety, floppety and you get nowhere.

Yesterday came word that the US deficit for 2009 might come in lower than expected. Instead of borrowing $1.8 trillion as anticipated, the feds might only borrow $1.58 trillion. Well, that still leaves them about $680 billion short – even if every dollar of trade deficit and every dollar of domestic savings is applied to it. But definitely a step in the right direction! This gap must be closed by quantitative easing, or, in other words, by printing press money. So, holders of old dollars are bound to wonder how much their savings will be weakened by the addition of so many new ones.

They’re likely to wonder, too, how much those US Treasury notes will be worth after this monetary inflation catches up to them. At some point, they are likely to think twice about buying more of them…and possibly even want to sell the ones they have already. Either way, it could create a nasty financial whirlpool that sucks down the entire world economy. As private investors reject US dollar credits, the Fed would be forced to print up more money to buy them itself. As the Fed buys more, private investors become more fearful that this monetary inflation will lead to consumer price inflation; they may panic and dump all dollar-denominated assets.

But if investors drop the dollar, what do they take up in its place? Oil…maybe. Oil is selling for $72 a barrel, even while the world is in a major downturn. What makes it so expensive, if not the fear that the currency in which it is quoted is more slippery than the black goo itself?

And gold? Yesterday, gold lost $3. But is still trading in the mid-$900s – not far from its all-time high. And this at a time when consumer price inflation is going down! In the US non-oil export prices are falling at a 5% rate. If people are buying gold as a hedge against inflation, they must know something we don’t. Consumer prices are falling…actual CPI rates are negative in many countries already. Take out the effect of speculation on oil and commodities, and deflation is probably a fact of life almost everywhere. Gold buyers are not hedging against an increase in the price of bread, in other words; they’re hedging against a poison arrow directed at the dollar itself.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.