Dollar down! Medic!

We've been building our economy on a shaky foundation of debt and instant gratification for some time now. The longer any addiction lasts, the worse the withdrawal...especially if going cold turkey isn't voluntary.

So many people put faith in the Federal Reserve's ability to pull rabbits out of the hat to conceal the structural problems. But even the Fed can't repeal basic economic laws like supply and demand. Nations like China and Japan hold trillions of dollars (due to their trade surpluses with the US and purchase of our public debt). There are two primary reasons this has been attractive for them: first, oil trading has been denominated in dollars since the 1970s, giving our currency an exclusive advantage independent of the prudence of our economic choices. Second, the interest rates typically offered for dollar-denominated assets have been competitive with or superior to those of other currencies. These artificial supports that have allowed us to literally print our own money at will are starting to break down:

Dollar hits record low trading against Euro
Canadian dollar reaches parity with US$ -- first time in 30 years
Why is the dollar losing value?

The bottom line: our voracious consumer appetites, coupled with a desire to get more government goods than we're taxed to pay for, ramped up the supply of dollars and dollar-denominated debt until the entire world is awash in it. Foreigners who enabled our foolishness are now realizing the risk they are carrying and are trying to mitigate it by carefully getting out of dollars into other currencies, commodities or other tangible assets.

What this means is it's less attractive now to hold dollars, which will be exchanged wherever possible for tangible goods that aren't subject to the dollar's current fluctuations. Once this reaches a certain tipping point, however, the cycle could begin to feed on itself--as more people seek to exchange their trillions of dollars for goods, the number of dollars demanded for assets will be bid up. It's simply the law of supply and demand... with an oversupply of dollars, and a diminishing demand for them, their value will fall.

While that will be a major headache for tycoons dealing in nine-figure transactions, it will have far heavier repercussions for those who just need to pay for the basics of life. Somebody, somewhere, was going to have to foot the bill for our two-decade long spending binge. Guess who it may turn out to be?