Economists have long predicted the dollar’s demise as the global currency of choice.  Some, such as Paul Krugman, hailed it as a means of correcting the American trade imbalance.  Love it or hate it, the weakening of the American dollar has begun as central banks have started to buy euros and yen while dumping the dollar (via Instapundit):

Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two- quarter rout in almost two decades.

Policy makers boosted foreign currency holdings by $413 billion last quarter, the most since at least 2003, to $7.3 trillion, according to data compiled by Bloomberg. Nations reporting currency breakdowns put 63 percent of the new cash into euros and yen in April, May and June, the latest Barclays Capital data show. That’s the highest percentage in any quarter with more than an $80 billion increase.

World leaders are acting on threats to dump the dollar while the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors. The diversification signals that the currency won’t rebound anytime soon after losing 10.3 percent on a trade-weighted basis the past six months, the biggest drop since 1991.

This could not come at a worse time, as the current American administration busies itself with massive new spending — and massive new debt.  The weaker dollar will make the sale of Treasuries that much more expensive, which should warn the US government away from further deficit spending.  The biggest problem afflicting the dollar, Bloomberg reports, is that there is just too much of it on the market, thanks to the increased need to cover deficit spending and the monetary policy that accompanies that need.

Does a weak dollar matter?  Should Americans care whether our currency dominates world markets?  James Pethokoukis says that whether we should or not, the decline of the dollar will almost certainly become a large political problem for Barack Obama:

A recent Rasmussen poll, for instance, found that 88 percent of Americans say the dollar should remain the dominant global currency. Now, the average voter may not fully understand the subtleties of international finance nor appreciate exactly how a dominant dollar has benefited the U.S economy. But they sure think a weaker dollar is a sign of a weaker America.

And that’s the political problem for the Obama administration. Its benign neglect of the dollar is another example of an economic policy — along with TARP and the $787 billion stimulus — that the White House thinks is helping the economy, but many Americans find wrongheaded.

In his New York Times column today, Paul Krugman makes the usual case for a weaker dollar: It helps U.S. exporters and is a necessary part of a global economic rebalancing. And there is some truth in that, particularly the idea that Rising Asia will result in a less-dominant dollar. Then again, a devalued currency hasn’t exactly been a proven path to prosperity. (Ask Jimmy Carter.)

But Krugman too easily dismisses the idea that the dollar’s decline could tumble out of control. Former Clinton economic officials such as Robert Rubin and Roger Altman have been making the case that investor concern about budget deficits could lead them to abandon the dollar. As Altman argued in a Financial Times op-ed piece today: “The dismal deficit outlook poses a huge longer-term threat. Indeed, it is just a matter of time before global financial markets reject this fiscal trajectory. That could lead to a punishing dollar crisis.”

Pethokoukis imagines a campaign slogan for 2010 and 2012 being, “Who lost the dollar?”  It might make for a good slogan at that, but blaming it all on Obama would be a little too easy.  The crisis has its roots in policies that go back at least a decade, and in deficit spending that began to get out of hand with a Republican Congress and Republican President and went insanely wrong when Democrats took control.

However, Obama’s fiscal policies are the worst we’ve seen in a generation.  In a crisis which demands a return to fiscal sanity, the White House has instead become the asylum, as these deficit projections show — even without ObamaCare and cap-and-trade:

Instead of finding new ways for the federal government to spend money, Congress and the President should be finding new ways to curtail it and demonstrate that we intend to end our irresponsible spending and massive government overreach into the private sector.  In that sense, we can blame Obama for losing the opportunity to stop the dollar crisis before it reaches a tipping point.