I’d blame this on the Presidential Temper Tantrum, but the proximate cause of the US dollar’s overnight decline was actually Cheerful Ben Bernanke.  After the Fed chair told Congress that a third round of quantitative easing might be in the offing if deflationary pressure began building, the market in Asia called his bluff and began dumping the greenback.  One JPMorgan analyst called that news “unambiguously bad for the dollar” (via Instapundit):

The U.S. dollar was on the run in Asia on Thursday after a ratings warning from Moody’s and a hint of further policy easing from the Federal Reserve unleashed a wave of panic selling, much to the relief of the hard-pressed euro. …

“Three months ago all the focus was on the exit from unconventional policy; now Bernanke mentions the conditional possibility of QE3,” said Paul Meggyesi at JPMorgan. “This is unambiguously bad for the dollar and good for risk.”

Investors seemed to agree, sending commodities and gold higher and lifting growth-leveraged currencies like the Australian dollar.

The U.S. dollar slid to a fresh record low against the Swiss franc around 0.8089 francs, while the euro leaped to $1.4253 having been as low as $1.3984. The dollar also deflated to 78.83 yen with only talk of semi-official bids preventing a break of major support around 78.40/50.

Against a basket of currencies, the dollar was down at 74.773 .DXY, having tumbled for a high of 76.053.

The New Zealand and Australian dollars were the big winners in the Asian market overnight.  Unless Congress and the White House can agree on an approach to limiting spending and authorizing debt, this might just be a taste of what will come by the end of this month.  Investors have “growth-leveraged currencies” to which they can flee the dollar, and not just in Australia and New Zealand.

Even with a deal, though, the US economy will drop into recession, according to Gary Shilling, and it will be a further decline in the housing markets that will do the trick:

Gary Shilling, President of A. Gary Shilling & Co. and author of the Age of Deleveraging says another recession is brewing — no matter what action the Fed takes. “Economic growth here and abroad is slipping, making a 2012 recession a distinct possibility,” he writes in his July newsletter. And, “when you have slow growth it doesn’t take much of a shock to throw you in negative territory.”

Shilling says the shock to trigger the next recess is “another big leg-down in housing.” (An asset class the Fed has not been able to reflate.) As those familiar with Shilling know, his forecasts are generally bearish.  However, in his defense, Shilling was one of the few economists who correctly predicted the dangers of the subprime mortgage market and its impact on the broader economy.

The problem with the real estate market remains excess inventory. Based on Shilling’s research, there are 2 million to 2.5 million excess homes in the country — a supply that will take 4-5 years to work-off. The result: Housing prices will fall another 20% and underwater mortgages will balloon from 23% to 40%, he says.

It’s not just the excess inventory — it’s the still-inflated valuations, too. We still haven’t relinked house values to historical inflation, according to the latest S&P/Case-Shiller report:

The Fed can’t do anything to “reflate” the market, and it shouldn’t try.  That’s been the problem in this market for the last 13 years.  The government tried inflating the market, at first inadvertently with mortgage interventions in order to press for broader home ownership, and later to allow homeowners to use their houses as ATM machines to spend money that really didn’t exist.  The 20% decline that Shiller forecasts would put us about on the track where home values would have been had government not intervened and created a bubble that separated home values from inflation, which had been linked for decades.