Dollar in the dump

The massive bailout of the financial sector, valued at nearly $1 trillion, is causing a record deficit, which is sinking the dollar. Already investors have started moving away from dollar into commodities. Commodities across the board like Gold, Oil, Copper etc are seeing a massive rally. (Oil price increased by almost $35 to $130, and is expected to go up.) The details of the bailout have also not emerged completely, leading to volatility, which is only expected to get worse.

Dollar's position as a reserve currency will be challenged if the slide continues. China has billions of US dollars in reserves, so if it sees that the dollar value is dropping, it may start dumping its dollar assets in favor of other more resilient assets. Other countries also have substantial dollar reserves. This would release a lot of dollars into the global markets putting much more downward pressure on the dollar. The only reason against that happening now, is that the Euro, the nearest alternative, is also in a pretty bad shape.

To control the drop in dollar, the government has to reduce the deficit. One way is to reduce expenditure, which appears to be nearly impossible due to the bailout plans of Paulson. The other alternative is to increase taxes, which is equally unlikely. A weak dollar will cause much harm to the economy and raise inflation, leading to a very damaging recession.

A positive effect of a weak dollar is that it will increase exports, and make imports more costlier. But this is a long term effect, which wont necessarily kick in, in the short run.

The current bailout, as bad as it is, is the only way to offset much bigger crisis in the American economy. But the loss of confidence in the dollar will take a long time to recover.