The Diving Dollar.

The dollar is weak in Europe, weak in Japan, weak against every currency save the Brazilian real, signaling perhaps the end of the strong dollar as we have known it, currency trader Dennis Gartman wrote in his insider newsletter last week, finishing with an ominous quote from "a former African central banker" and "seasoned observer of the world." The banker warns that the euro is "slowly but surely easing out the dollar from its half-century dominance as the reserve currency of the world" and raising an immediate threat. Invoking the long history of currency meltdowns, most recently in Latin America, the banker concludes: "The turn for the dollar to melt may be at hand!"

For serious people to talk this way gives you some sense of the melodrama surrounding the fall of the dollar. Before World War II, banks held gold in reserve as proof of their stability. Afterward they shifted to dollars, in recognition of America's burgeoning status as sole superpower. Following a 9 percent plunge in the dollar against the euro this year, the emerging consensus is that the bottom is a long way off. Does the fall end with the dollar's losing its status as the world's reserve currency or melting down like the Argentine peso, as the African banker warns? "We think not," wrote Gartman, "but we are certain our friend is right that the central banks of the world" will shift away from a "preposterously imbalanced" bias for holding dollars above all other currencies.

This is no ordinary swing in the dollar. It's a belated backlash against the hype of the New Economy, when foreigners buying American stocks or bonds drove up the price of the dollar to levels as inflated as the bubble itself. Now, with the United States struggling to avoid recession, foreign investors are demanding better prices, spooked by the rising U.S. deficit and attracted by higher interest rates elsewhere. Even bankers in China, key financiers of the U.S. deficit, warn that they can't keep buying dollars fast enough to sustain America's $1.9 billion-a-day borrowing habit.

When the U.S. Federal Reserve hinted last week that it is starting to worry about deflation (as well as inflation) for the first time, investors saw this historic shift as another reason to dump the dollar. If American prices are at risk of falling, why hold dollar assets? After the Fed's remarks, the dollar fell a further 2 percent against the euro. Jim O'Neill, global currency strategist for Goldman Sachs, expects the dollar to sink for four to five years more: "We are nowhere near the end."

The strong-dollar era is ending in a clash of the two most powerful legacies of the 1990s: the bubble hangover and the spread of free- market ideals. Most analysts expect a gradual but not painless collision in which markets allow a sharp correction in the dollar, which makes U.S. exports more competitive, reviving the U.S. economy and the world economy with it. Merrill Lynch currency strategist Alex Patelis points out that the U.S. economy grew from 1985 to 1987, during a period when the dollar ...