The big news this past week was definitely the dollar.

Yesterday, the 14-day relative strength index of the euro versus the dollar fell to 21.82, the lowest since the European currency’s 1999 debut.

The question is: How can the dollar rally like this when the greenback’s fundamentals leave so much to be desired?

Currency expert Jack Crooks says the key to understanding current dollar strength is the failure of other nations to decouple from the ailing US economy…

It seems the sub-prime fiasco created bigger problems for the U.S. financial system than everyone thought. And now we’re seeing this economic virus spread to other areas of the globe.

Need Evidence? It’s All on the Nightly News

It’s pretty easy to see other countries are feeling our same sub-prime pain. Just look at these recent news stories…

• German industrial orders dropped sharply – by 2.9% in June. That’s disconcerting considering Germany’s economy makes up one-third of total Eurozone output. And speaking of the rest of the Eurozone, many of those economies are bogged down by housing busts just like us.

• The International Monetary Fund (IMF) called out the U.K. economy. They predicted the U.K. would grow 1.8% and 1.7% for 2008 and 2009, respectively. All I have to say is: Kiss those numbers goodbye. The IMF’s latest forecast calls for a seriously lower 1.4% in 2008 and 1.1% in 2009.

• Australia is battling sluggish household spending and their financial sector is being challenged. The National Bank of Australia recently reported a huge second quarter write-down, which they blamed on massive collateralized debt obligations (CDOs).

• And the New Zealand Treasury anticipates a second consecutive quarter of negative GDP growth. By definition, New Zealand will have entered recession once official numbers are released. They’d be the second OECD-member country since Denmark to sink to official recessionary status.

The reality is that the big three in the developed world – the U.S. the U.K., and the Eurozone – are staring into the face of recession.

How Does this Big 3 Recession Affect the Next “Superpower?”

As we were so often told when analysts were pushing the decoupling theory, China is set to take over the world.

But if weakness is spreading around the globe, what does that mean for China?

The 2008 Summer Olympics are just now beginning, and there’s news that pollution has grown to far worse levels over the last few months. Chinese officials are putting all kinds of limits on how many cars can be on the road on any given day.

Additionally, in an effort to minimize excessive air pollution, Beijing is closing 105 factories. And should conditions worsen, neighboring cities could close as many as 117 factories combined.

Anticipation of the games gave Chinese companies reason to ramp up production. But what’s concerning is these companies front-loaded production and an inventory glut is building up.

It makes you wonder how much extra production was jammed into the last quarter in order to prepare for air cleansing before the great games began.

I suspect plenty.

That’s never good because they will have to sacrifice growth for as long as it takes to work through the oversupply.

The Commodity and Currency Circle

If the global economy is slowing, and China is forced to work through excess inventory, demand for commodities will be impacted. I’m guessing crude oil prices, in particular, will suffer from the realities I just described.

And remember, commodity prices and currencies influence each other in a self-feeding circle.

For example, falling crude prices could be the one thing that allows U.K. and European central banks to begin lowering their interest rates.

If and when that happens, the dollar will become more attractive relative to those currencies.

It wouldn’t take a bold move on the part of the U.S. Federal Reserve, either (nor do I expect one).

A narrowing interest rate disadvantage between the dollar and euro – or the dollar and the pound – would be hugely supportive for the greenback.

In fact, this may very well be why the dollar HAS ALREADY been holding up given such incredibly dismal news day after day from the U.S. economy.

Take a look at this chart …

 

Are Oil and the Dollar Finally Breaking Their Inverse Relationship?

Over the last year or so almost everyone’s been pointing to the inverse relationship between the U.S. dollar and crude oil.

At the very left of the red rectangle on my chart, you can see where the tight inverse correlation began to break down. That’s when the dollar bounced higher from its all-time low. Crude soared well beyond its record high at the same time.

Crude rallying and the dollar drifting slowly higher simultaneously? That was certainly no inverse correlation.

But from the furthest right point of that red box is where the tight inverse correlation has resumed. Only this time, the direction is in favor of the dollar. And it comes exactly after a new all-time high for crude prices.

Translation: The buck could be back.

The dollar has been able to continue its rally this week, even amidst a blitzkrieg of central bank announcements. While it has a long way to go – and recovery may not be swift – I think it’s time to keep the dollar rally scenarios in clear sight. Especially now that other economies are catching the bug.

Source: Is the Dollar Really Making a Comeback Tour Here?