The Dow stabilized yesterday...but the dollar continued to drop.

“I sold all my stocks,” said an old friend yesterday. “I just think this is going to get worse.”

Our old friend is neither an economist nor an investment analyst. But he dresses well. He was wearing square-toed shoes long before other men we know. He is a trendsetter; maybe more in tune with the ‘zeitgeist’ of our time than an economist would be.

Success is a hard thing to overcome. After so many years of generally rising prices, it is hard to see a downturn coming. Here at The Daily Reckoning, of course, we have been seeing a downturn coming for the last eight years. The economy needs a correction; we’ve been waiting for one for a long time.

But now, for whatever reason, our friend feels the time has come.

We don’t know, but we find a sense of gloom spreading within our own business. On a conference call last night, we found our U.S.-based colleagues unusually fearful.

This is not the time for new projects...not the time to make new investments...not the time to take risks, they seemed to agree.

It is funny how these attitudes creep up on you. They come in the night, when you don’t see them. You wake up in the morning and they have taken over your body. You find yourself wanting to slash costs...slash capital spending...and slash your wrists.

It may be that the fundamentals are exactly the same as the day before. But suddenly, you sense that trouble is coming...and that you had better be careful.

As the dollar falls, so does the wealth of dollar holders – particularly Americans. We checked this morning and found the dollar had dropped to over $1.38 per euro. Last week, we paid $5 for a cup of coffee in London. And the price keeps going up.

Why is the dollar falling?

Speculators, investors, and central bankers have figured out that the U.S. government and the Bernanke Fed will not protect the dollar – not when millions of Americans are having trouble making their mortgage payments. The U.S. money supply is increasing – nearly five times faster than GDP growth. And now, fearing a Japan-style deflation, the Fed is likely to cut rates later this month.

The Chinese have one of the largest dollar piles in the world.

“Is China quietly dumping US Treasuries?” asks Ambrose Evans-Pritchard in the English press.

“A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable.”

The report continues:

“Data released by the New York Federal Reserve shows that foreign central banks have cut their stash of US Treasuries by $48bn since late July, with falls of $32bn in the last two weeks alone.

“‘This comes as a big surprise and it is definitely worrying,’ said Hans Redeker, currency chief at BNP Paribas. ‘We won't know if China is behind this until the Treasury releases its TIC data in November, but what it does show is that world central banks are in a hurry to get out of the US. They don't seem to be switching into other currencies, so it is possible they are moving into gold instead. Gold is now gaining momentum across all currencies and has broken through resistance at 500 euros,’ he said.

“Two top advisers to the Chinese government gave strong hints in August that Beijing should use its estimated $900bn holdings of US Treasuries and agency bonds as a ‘bargaining chip’, words taken as an implicit threat to trigger as US bond crash if provoked.”

The Chinese have denied it, of course. But betting against the U.S. dollar has been one of the surest gambles you could make over the last 35 years. Now, it is probably still a good bet.

“Hey,” writes an American friend in Paris, who suffers the fall of the dollar every day, “I strongly urge you to take a look at the chart at the link below. It's from the Fed. It shows the Fed's trade-weighted dollar hitting an all-time low since the index was established in 1971. Check this picture out.



“Here we are at an all-time low on the dollar. All time.

“Is it a buy then?

“Well, what possible argument could you make for buying the dollar right now? That interest rates are going to rise to double digits again, like they did after the 1982 recession?

“Wait, I thought we were talking about the Fed cutting rates. How will the dollar if the Fed cuts rates? Oh, you mean it won't?

“Can you imagine what would happen to those two million ARMs set to reset in the next two years if the Fed hiked rates?

“No...the Fed won't be raising rates. So where does the dollar go from here? Here's what traders are telling Bloomberg about the dollar and Treasury bonds:

“‘The only component we can be confident about as nations diversify currency reserves is that Treasuries will be sold.’ Sean Callow said at Westpac Banking here in Australia.

“China will ‘reduce its holdings of dollar assets to get higher returns,’ says Ha Jiming, the chief economist at Beijing International Capital Corp.

“I like what Masayuki Yoshiara said. He manages $25.9 billion for Sumitomo Life in Japan: ‘We're not so bullish on the dollar.’

“Me neither.

“And when you look at that chart and consider the Fed will probably cut rates in the next ten days...it makes you wonder if gold isn't about to go to $1,000 in the next eight weeks.

“I guess the other question you could ask is when and why would you buy the dollar. For yield? For safety? For old time's sake?”

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