The Drudge Report headline today: "Dollar Plunge; Fear over Debt." Lots of people worry that the possible downgrade of U.K. debt is just a forewarning of what will eventually happen to the U.S. as the Treasury prepares for an avalance of debt sales that could last for years.
Not wanting to join immediately in the hysteria, I offer this chart as a way to begin to put things in perspective. The dollar is indeed weak, and it could get weaker, but in inflation-adjusted terms it's only about 5% below its long-term average.
However, the dollar's true weakness is being masked these days because all major currencies are falling against objective benchmarks, the principal one being gold. All major central banks, with the possible exception of the Bank of Japan, have followed the Fed's lead and are pursuing very accommodative monetary policies in an effort to pull their economies out of the current recession/financial crisis.
So it's not really a "dollar collapse" that is of concern, it's the potential for a revival of inflation around the globe.
To be sure, the U.S. will be selling mountains of Treasury bills and bonds for as far as the eye can see. But that is not the source of inflation. What is potentially inflationary is the Fed's purchase of significant amounts of that debt, otherwise called debt monetization. When the Fed buys Treasury bonds it is equivalent to the Fed printing up some money and handing it to Treasury so that Treasury can pay the government's bills. This is how Argentina operated for many years, and after a long time (decades) it finally led to what might be called hyperinflation. We're a long way from something like that.
When we see gold and other commodity prices rising, it tells us two things: one, global demand is reviving as the worst of the financial panic has passed; and two, everywhere, people and governments (e.g., China) are deciding that they don't need all the money they accumulated during the panic (otherwise referred to as a collapse in money velocity). By trying to unload their unwanted money balances they are pushing up the prices of things (otherwise referred to as rising money velocity). Money was something that people were desperate to acquire and hold onto; now it is becoming a sort of hot potato. It is getting passed around instead of sitting in bank accounts, and that is lifting prices.
I imagine we are only in the early stages of this process. At some point central banks will see this and other signs of recovery and begin to withdraw the money they have injected into the global economy. Whether they do that in a timely fashion should be the real focus of everyone's attention. If they err on the side of caution, as seems likely, we will see inflation rise.
UPDATE: I note this speech from the People's Bank of China regarding a global currency reform proposal. Seems to me that Robert Mundell has been educating these folks. They are now pushing for a monetary system that would be at least partially anchored by some objective standards. Some good news amidst the gloom. http://www.pbc.gov.cn/english/detail.asp?col=6500&id=178