There was an old woman (US Dollar) that swallowed a fly (inflation).

"There was an old woman who swallowed a spider,
That wriggled and jiggled and tickled inside her,
She swallowed the spider to catch the fly,
I don't know why she swallowed the fly,
Perhaps she'll die."

This poignant nursery rhyme depicts the crisis that the US Dollar now faces. In spite of Bernanke's and the Fed's persistence that they want a strong dollar, they are doing everything in their power not to see it accomplished. Within 30 days the value of gold has shot up over $100 per ounce. For the year gold has moved $219 for a gain of 35%. This is in the face of the Fed's constant easing of interest rate. Can the Fed successfully save the economy and rescue the dollar's downward spiral? Not likely.

The Fed's choice to ease interest rates has lead to an excessive amount of US dollars in the global economy. In today's world, currencies are just like any other commodity when there is too much off it, it's value diminishes. By pumping US dollars into the economy, the problem they were trying to stifle, collapsing housing market, has caused a worse problem, full-blown currency devaluation resulting in inflation.

While Bernanke's approach at decreasing interest rates was meant to soften the sub-prime lending collapse and ease down the economy, it may have been too much too fast. By not taking measured steps they overlooked the three key factors that work against a soft dollar.

First, the US is a net importer of products and commodities, regardless of what value the dollar has. As of this writing the US's trade deficit has reached over $610 billion dollars, and counting. So while US products are theoretically less expensive it doesn't mean they are anymore desirable. It is unlikely that a weak dollar can stimulate the US economy back to recovery through exports alone.

The second problem that a weak dollar faces is the huge amount of dollars that are sitting in foreign banks. These excessive reserves put the US economy at the mercy of foreign central bank policies. As interest rates are weakened dollar backed securities are no longer an attractive investment. This diminishes the amount of treasury securities purchased and begs the question of what should the foreign central bank's do with the treasury securities they already have? All of our major trade partners are facing just this dilemma. As the value of their treasury securities are are being eroded on two fronts, interest rates and currency value simlutaneously.

Finally the US simply can't compete with the level of market manipulation that is occurring worldwide. It's like being the only sheep in a pack of wolves. The Chinese yuan's dollar peg for the past decade has put a surplus of over $1 trillion US dollars in China's hands, no amount of short term aggressive approach to US exports can change that. The majority of this dollar surplus is tied into US Treasury Securities. Japan is not much better. They have a record $913 Billion in foreign currency reserves and at the same time are denying any inflation pressures. Their denial is in the face of doubling oil prices and a 23% increase in food costs.

Which leads us to the question. What should Bernanke and the Fed's do?

It has never been in the best interest of the Fed to attempt to manipulate the US economy. Greenspan failed to stop the dotcom bubble which quickly evaporated $7 trillion dollars in wealth in spite of his actions and warnings. There is nothing Bernanke can realistically do to soften the blow of the $21 trillion dollar real estate market. Any continued collapse in the sub-prime loan marker or Adjustable Rate Mortgages (ARM) will happen inspite any intervention by the Feds, and in fact maybe exacerbated by their continued intervention. An easy money policy, an increase in the M3 money supply, does not necessarily mean that there will be a trickle down effect to the consumer. In fact it sets the stage for the US to mirror what exactly happened to Japan during it's 12 year economic recession, a country despearately trying to give away money at 1% and litterally going nowhere.

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