Is the dollar doomed?

While the greenback has recently weakened against global currencies, some strategists think a dollar rebound is on the horizon. Others worry about inflation.

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By Paul R. La Monica, editor at large

The dollar rallied against the euro at the height of last fall's financial panic and moved higher again earlier this year. But the dollar has weakened lately, causing some to worry about inflation.
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NEW YORK ( -- Don't look now. But the dollar is starting to weaken again against the euro, pound and yen, leading some to wonder if its days as the world's No. 1 currency are numbered.

The euro was trading at about $1.406 on Friday morning, near a two-week high. Though the euro is still more than 10% below last summer's all time-high of $1.6037, the dollar's recent sharp slide has some concerned.

On Friday, Chinese officials reiterated calls for a so-called super-sovereign reserve currency that could supplant the dollar. China's opinion has obvious weight considering that it is the largest owner of U.S. Treasurys.

But the talk of the dollar's imminent demise appears, as Mark Twain once wrote, to be greatly exaggerated, according to some currency strategists.

"Talk of moving away from the dollar as a reserve is overblown. There will still be a lot of faith in the dollar in bad economic times," said Dan Cook, senior market analyst with IG Markets in Chicago. "The world is still looking to the U.S. to get out of this turmoil. Most blame the U.S. for getting the world into this mess after all."

Surprisingly, continued economic weakness is probably good news for the dollar because it could lead foreign investors to rush back into the dollar as a safe haven.

Cook said that much of the rise in other currencies has been at the expense of the dollar because it showed that investors were starting to believe that the global economy was on the mend.

In other words, they didn't need the dollar anymore. But Cook said that the dollar could quickly rebound if next week's jobs report for the month of June shows a continued spike in the unemployment rate.

Even though stock market investors cheered the May job report, which showed that the pace of job losses was decelerating, Cook said that investors might not be so forgiving if the official unemployment rate inches closer to the psychologically important level of double-digit status.

The unemployment rate hit 9.4% in May and economists are forecasting a rate of 9.6% for June, according to

"Next week's jobs numbers could be huge. If the numbers are worse than expected, that could lead to sustained strength for the dollar," Cook said. "Until the U.S. consumer is really back in the game, it will be difficult for a recovery to happen, especially if the unemployment rate is heading toward 10%."

To that end, consumers continue to save more than spend. The government reported Friday that the personal savings rate was 6.9% in May, up from 5.6% in April and the highest level in more than 15 years.

Talkback: Do you think the dollar will continue to weaken? And are you concerned by the dollar's slide? Leave your comments at the bottom of this story.

Others think the dollar will bounce back soon simply because, as bad as things may seem in the United States, they're even worse in other parts of the world -- particularly Europe.

In a report earlier this month, currency analysts for Bank of America Merrill Lynch in London wrote that they expect bank writedowns in Europe to lead to a big boost in dollar purchases.

Here's why. Many European banks raised deposits in the United States and by doing so, created liabilities on their balance sheet. That's because a deposit is really a loan to a bank. These banks then used those deposits to try and make a profit by making loans in dollars or purchasing securities in dollars.

But since the value of many of those loans and securities have declined dramatically, the only way the bank can repay its liabilities is to do some from its own equity, which would be denominated in euros instead of dollars. So the banks would have to sell euro-based assets and purchase dollars in an amount equal to the writedown.

The BofA Merrill analysts estimate that there is between $100 billion and $462 billion in writedowns of dollar-based assets by foreign banks still yet to come, creating a nice floor of demand for the dollar in the coming months.

If the dollar does actually bounce back, that could be a welcome relief for consumers. The prices of many commodities are tied to dollars. So the dollar's weakness is one reason behind the recent rise in oil and gasoline. A stronger dollar also makes it cheaper to buy imported goods in general.

In addition, a stronger dollar would give the Federal Reserve, which left interest rates near zero at its latest meeting this week, more wiggle room to keep stimulative policies in place longer to try and ensure that the economy doesn't take a step backward.

But as long as the dollar continues to weaken and prices of commodities rise, that will spark more inflation fears, which could force the central bank to pull back on its various lending programs more quickly than it would like.

Some fear bigger dollar declines

Still, not everyone is convinced that a dollar comeback is in the cards. Axel Merk, president of Merk Mutual Funds, a Palo Alto, Calif.-based money manager specializing in currency investments, said he thinks the dollar will remain under "significant pressure."

Merk argues that if the dollar was still viewed as a safe haven, it should be rallying now that there is increased skepticism about the prospects for an economic recovery. He said the reason it isn't is because investors are worried about the potential inflationary impact of stimulus.

"The U.S. government's balance sheet has deteriorated because of all the spending. The Fed desperately wants to have higher home prices and it's printing so much money to try and drive down rates," Merk said.

Merk calls this a "dangerous road" that could cause more investors to flock to the euro over the dollar. He said a return to last year's highs for the euro is not out of the question.

"Why have money in the dollar when other countries aren't as reckless with their monetary policy?" Merk asked.

Talkback: Do you think the dollar will continue to weaken? And are you concerned by the dollar's slide? To top of page

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