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Dollar approaches critical levels

The dollar continues to trade lower, and is now only a few percentage points above its all-time lows against other currencies, both nominally and in inflation-adjusted terms, as shown in these two charts above.

Bernanke's speech this morning provided no comfort for dollar bulls, since once again he all but guaranteed that monetary policy would extraordinarily accommodative for a long time, while also remaining relatively downbeat on the prospects for the U.S. economy. He promised the dollar would remain a strong currency, however, and he noted that the Fed was watching the dollar's value, but he utterly failed to say how the dollar might rise from all-time lows to a level that might be considered strong. He also failed to comment on the significance of gold reaching another all-time high of $1140/oz., and what that says about the dollar's value and the Fed's stewardship of the currency.

A dispassionate observer would undoubtedly conclude from all this that the fundamentals couldn't be much worse for the dollar than they are today: weak economic growth prospects, astoundingly profligate fiscal policy, massively accommodative monetary policy, and an almost total absence of any official concern for the value of the dollar. But the same observer would also note that the dollar's value today is largely consistent with these fundamentals.

So where does that leave us? When the fundamentals are awful and the pricing is awful, then awful things must happen, otherwise the market is going to have to rethink its position. I think that as the dollar approaches its all-time lows the situation is increasingly ripe for some big shocks to consensus thinking. Perhaps the economy isn't as weak as everyone seems to think. Perhaps the Fed won't have to keep short-term rates at zero for another year.

Meanwhile, dollar weakness continues to go hand in hand with equity market strength, as this chart, which I have been showing repeatedly, shows. My theory for why a weak dollar is good for the stock market is that the dollar's weakness is a reflection of a rebound in money velocity, and that in turn is fueling an expansion of economic activity worldwide. There is at least one silver lining to the dollar's otherwise miserable condition.

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