The Future of the Dollar; Jumping up is not likely--not with that debt burden.

Byline: Stephen Glain

The smart money is betting, once again, that the days of the almighty dollar are numbered. And just because this prediction was startlingly wrong for 2005 doesn't mean it's wrong again for 2006.

After a yearlong bull run fed by rising U.S. interest rates, political disarray in the euro zone and sustained dollar buying by Asian central banks, the dollar is running out of fuel, say economists and investors. The latest warning shot came when the European Central Bank, led by president Jean-Claude Trichet, earlier this month raised its basic interest rate for the first time in 30 months, a move that could attract investors to the euro. After the first quarter of 2006 "things get dicier" for the dollar, says Anton Pil, global head of fixed income for JP Morgan Private Bank. "You'll start seeing the unwinding of dollar positions back into euros and yen... and then the debt cloud will re-enter the picture."

Over the last year, the dollar rose about 15 percent against the euro and yen. That defied virtually all forecasters, who thought America's growing debts would chase investors away from the dollar, and occurred despite a continuing run of news that, in theory, should have depressed the currency: the troubles in Iraq, record-high oil prices and hurricanes on the Gulf Coast.

How could that happen? Even as America's trade deficit continued to swell, hitting a record $66 billion in September, concern about its potentially harmful effects was muted by generally strong and inflation-free economic growth. Meanwhile, the Fed was gradually making the dollar more attractive by raising rates in quarter-point steps, or a total of 1.75 percentage points over the year, to 4 percent. This steadied the nerves of investors who "carry" dollars and dollar-based assets in short- to midterm trades for the higher returns they offer, compared with what's available in slow-growth Europe and Japan. In a move not widely noted outside financial circles, the Bush administration also dramatically cut taxes on profits remitted to the United States, from 35 percent to 5.5 percent. That added further stimulus to the dollar at a time when political chaos in Europe, from race riots in Paris and France's rejection of the EU constitution to the inconclusive outcome of elections in Germany, was undermining the euro.

Asian central banks, which sell their own currencies for dollars to enhance their export competitiveness and account for more than half of the world's $2.5 trillion in foreign reserves, continued to be loyal dollar ...