(FORTUNE Magazine) – As much as they might have liked to, overseas investors couldn't vote when Americans went to the polls last month. But that doesn't mean their views don't count. In the weeks since the election, international displeasure with President Bush and U.S. fiscal policy has helped push the dollar down more than 3% against the euro to an all-time low of $1.32, while the greenback now fetches fewer Japanese yen than at any time since 2000.

It's a powerful reminder that even in an age of go-it-alone foreign policy and unilateral military action, the rest of the world still matters when it comes to economics. Indeed, while the administration may have ignored European objections to removing Saddam Hussein, the falling dollar now has Washington's full attention, not to mention Wall Street's. In late November, no less an authority than Fed chairman Alan Greenspan cautioned that mounting trade and budget deficits pose a threat to future U.S. economic growth. Notably, Greenspan's warning wasn't delivered in New York or Washington--he spoke to an audience of bankers in Frankfurt, the home of the euro. Making the rounds in Europe the same week was Treasury Secretary John Snow--nicknamed "Der Dollar-Killer" in the German press--who said he preferred to let the market sort out the exchange rate rather than advocate the kind of intervention a former treasury secretary, James Baker, favored in the 1980s.

While the decline of the dollar has so far been benign, fears are growing that a more rapid devaluation could send interest rates surging and crimp economic growth in the years ahead, especially if Washington doesn't get its fiscal house in order. By the end of November the falling dollar had replaced oil prices as Wall Street's chief worry, and doomsday scenarios from the 1970s about a dollar crash and inflation were being dusted off. "When the market saw how clear the Bush victory was, with stronger Republican majorities in both houses of Congress, people thought, 'There will be no quick deficit reduction,' " says Thomas Mayer, chief European economist for Deutsche Bank in London. In Europe's view, GOP plans to partially privatize Social Security while making some of the tax cuts passed in Bush's first term permanent could dramatically worsen the deficit, which hit $413 billion in fiscal 2004.

The decline of the dollar against the euro has been especially steep, since export-oriented Asian countries are less willing to let their currencies appreciate. China's yuan doesn't float freely and is officially pegged to the dollar, while Japan's central bank has a long history of intervening to keep the yen from rising too sharply. So while the dollar has dropped 6% against the yen over the past year, it's off 10% against the British pound and 11% against the euro. "The hope here is that Asians will join in and share the burden of a weak dollar," says Mayer. "But we are resigned to seeing the euro go up and take up the slack."

Unfortunately, that's the last thing Europe needs right now. Economies on the Continent have been barely growing for the past several years, and weaker demand from the U.S. will make it that much harder for governments in Paris, Berlin, and other European capitals to improve domestic job and profit growth. And although Europeans fret that they're shouldering the bulk of the dollar's decline, there doesn't seem to be much appetite among central bankers to intervene in foreign-exchange markets. If the dollar remains soft through the summer--and there's no reason to think it won't--airlines and hotel chains are also likely to be hurt by a drop in American travel to Europe. A room at the Ritz in Paris now costs $802 a night, up from $684 a year ago.

Both Snow and President Bush have publicly endorsed a strong dollar, but in reality neither seems unhappy with a falling currency, at least for the time being. That's because while a weak dollar might sound wimpy to American voters, it makes U.S. goods cheaper overseas and helps beleaguered manufacturers compete. The National Association of Manufacturers declared in mid-November that the "dollar isn't weak--it's still too strong," arguing that it is only coming back into balance following a surge in 2001 and early 2002. At the same time, a stronger euro and yen make imports less attractive, which should ease the $665 billion imbalance in trade and investment flows (the current-account deficit) that Greenspan is worried about.

That's the good news. The long-term picture is more ominous. With the U.S. requiring an estimated $2.6 billion every business day from overseas to fund the current-account gap, "a diminished appetite for adding to dollar balances must occur at some point," Greenspan said in remarks that were blunt, at least by the usual oblique standards of the Fed chairman. "This situation suggests that international investors will eventually adjust their accumulation of dollar assets ... elevating the cost of financing the U.S. current-account deficit and rendering it increasingly less tenable."

In other words, we can't go on like this much longer. "The Fed has woken up to America's current-account problem," says Stephen Roach, Morgan Stanley's chief economist, who ticks off threats to the American economy: anemic savings rates, swollen budget deficits, and the hard-to-kick habit of importing $50 billion more in goods and services a month than the U.S. exports. "We've been consuming beyond our means for a long time," Roach says.

Although foreign investors, especially central banks in Asia, have snapped up ever-increasing amounts of U.S. debt in recent years, there are signs they may be growing wary. The Russian central bank, which has more than $110 billion in foreign reserves, has signaled that it may shift some of that cash hoard from dollars into euros. China, which has $523 billion in reserves, most of it in dollar-denominated assets, hasn't lost faith in the dollar, but Beijing could easily decide to buy assets in other currencies, reducing the risks it faces if the dollar continues to weaken. Private overseas investors have already cut back on their purchases of U.S. government debt. The most recent Treasury Department data show that private investors accounted for 65% of foreign buyers of equities and bonds in the 12 months ended in September, down from 85% in 2003.

It's inevitable, Roach says, that the falling value of dollar-denominated investments will cause these foreign buyers to demand higher interest rates if they are to keep lending America the money it needs. "I don't have any doubt that America will be able to fund the deficits," says Roach. "It'll just be on terms less favorable to us, with higher interest rates and lower stock prices."

Other forecasts are even gloomier. C. Fred Bergsten of the Institute for International Economics in Washington, D.C., cites a perfect-storm scenario of a crashing dollar, soaring energy prices, and spiking interest rates that brings back memories of stagflation under President Gerald Ford. To be sure, would-be Cassandras have been talking about such dangers for years--in June 2002, Roach authored a report titled "What If the Dollar Crashes?" And while the dollar may now indeed be falling, the S&P 500 is still up 7.8% for the year, and the economy created 367,000 jobs in October. What's more, veteran observers will remember how 1980s pessimists warned that the Reagan-era deficits would cripple America's future growth. The 1990s, of course, turned out quite different, thanks to a combination of tax hikes, spending restraints, and economic growth that turned the government's $269 billion deficit in 1991 into a $236 billion surplus by 2000. One of those pessimists, Pete Peterson, is reprising his deficit-hawk role in a new book, Running on Empty.

So is the falling dollar just a passing anxiety, another one-hit wonder for the perma-bears? The answer is no, even if the most dismal forecasts probably won't come to pass. That's because while a gradual, orderly decline in the dollar might actually benefit the economy in the short term, the factors driving it down are genuinely worrisome. "This situation is much worse than it was in the 1980s," says Roach, who points out that the U.S. current-account deficit is equal to 5.7% of GDP, and that it's heading toward 6.5% to 7% by next year. "That's twice as bad as it was in the 1980s," he says. Yet the dollar has only fallen by 15% since early 2002 against a broad basket of world currencies, less than half of the percentage decline it experienced in the mid-1980s.

Assuming Roach is right and the dollar has further to fall, the key question becomes whether the decline will be what economists and traders term "orderly." A downward drift of 1% a month would constitute an orderly move, giving exporters time to adjust and avert serious economic damage. Between 1985 and 1995, for example, the dollar dropped by more than 50% against the deutsche mark, prompting German automakers to shift production to the U.S. and boost productivity. "As long as the changes happen over time, companies adjust," says Deutsche Bank's Mayer.

The 3% pace of the dollar's recent decline is edging toward disorderly. That raises the risk that stock and bond markets will be hammered, and that interest rates will have to be hiked to defend the currency and head off inflation. It's a vicious cycle and, as Thailand discovered in 1997 and Argentina in 2001, a difficult one to stop once in motion. "A very hard landing is not inevitable, but neither is it unlikely," says Bergsten of the dollar, adding that the best way for America to avoid this outcome is for Congress and President Bush to come up with a credible plan to cut the budget deficit. "There is still time to head off these risks," he says. "It should be feasible, having been more than accomplished during the 1990s."

Although both Bush and Snow are talking about halving the deficit over the next four years, it's unlikely Congress will be willing to adopt the tax hikes and spending cuts Bergsten is advocating. In the end, that means trouble for the dollar, even if Bergsten's doomsday scenario doesn't come to pass. It could also spell an end to the low interest rates that have buoyed American consumers and kept the economy afloat in recent years. Over the next year, Roach predicts, the yield on the benchmark ten-year government bond will rise from 4.2% to as much as 5.5%, with short-term rates jumping to 3%. Not only will that mean higher payments on mortgages and credit cards, but it bodes poorly for the stock market, since higher rates hurt earnings and make equities less attractive. The net result, Roach says, could be at least a half-point reduction in GDP growth next year.

For now, most Americans seem happy to reap the rewards of a cheaper, more competitive currency, especially in parts of the country hurt by the strong dollar a couple of years ago. In Buffalo, N.Y., Eastman Machine CEO Robert Stevenson says overseas sales of his fabric-cutting machines are surging, "with demand coming from places where we hadn't been doing business in quite a while because they thought our products were too expensive." He says he sold two $100,000 units to South Korean customers in recent weeks, a deal that wouldn't have happened even six months ago: "They're saving more than $15,000 because of the weaker dollar. The discount is wonderful for us."

What's wonderful now, though, could become much less pleasant for the rest of the world--and eventually for the U.S.--if Washington doesn't pay attention, if the dollar's decline doesn't remain gradual, and if foreign investors lose confidence. In that case, their votes will count.

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