Despite pathetic fundamentals in the US economy, America still stands as the sole economic superpower.  If you think our situation is bad, look at the UK, Europe, or Japan and their respective currencies.  It’s a bloodbath over there.

But then there is China.  As China is very well positioned to become the world’s largest exporter over the next years, the renminbi could challenge the dollar’s reserve currency status.  But one caveat remains, in that in order to become the world’s reserve currency, the Chinese government would have to float the renminbi and remove capital controls; not something we expect from the central planners in Beijing anytime soon.

In today’s Financial Times, David Woo, head of FX strategy at Barclays, had this to say about the state of the dollar:

Notwithstanding the problems with the current global reserve system, there are at present no obvious alternatives to the dollar. That said, US fiscal profligacy will push the dollar risk premium higher over time. In other words, the US’s ability to obtain cheap external funding for financing its twin deficits is likely to be curtailed. In the near term, the global economy remains too fragile to absorb the shock of a large and disorderly decline of the dollar. In that respect, the chances for coordinated intervention among developed economies to support the dollar are higher now than any time in the past 10 years.

So where does this leave you, dear reader?  How can you play a short to medium term, strong dollar?  Well, for one, hold dollars now. Or you could buy PowerShares DB US Dollar Index Bullish (NYSE: UUP) and hold it for the short to medium term.  But don’t forget about it.  The long term dollar story isn’t pretty.

That could be further from the truth…

Inflation is comprised of three things. One of them, is the velocity of money. If money is moving quickly from one hand to the other, inflation is more likely to pick up the pace. But if the velocity of money is slowing down, it means people are buying less.

As this credit crisis worsens, the velocity of money will continue to shrink. So it doesn’t matter how much credit the Fed creates, banks will refuse to lend because they know they will have bigger losses in the future that they’ll need to cover.

So far, the US Dollar has reacted exactly as you would expect if the velocity of money shrank…

The US Dollar Index Climbing Higher

This is a three-year weekly chart of the US Dollar index (which tracks the dollar’s value against six other major currencies). I chose a weekly chart because longer term charts tend to give clearer buy and sell signals (they just take longer to play out).

If you’ll notice, the USD spiked 22 percent higher beginning in July of 2008 and continued up until November. The fact that the dollar spiked on bad news is a huge bullish signal that shouldn’t be ignored.

And there are now three more reasons why the dollar is primed for a move higher…

1. The USD is finding support at a previous resistance line back formed in May of 2005.
2. The USD is also showing a bullish cross of its 200-week and 20-week moving averages.
3. And lastly, the slow stochastic and RSI both favor a move higher.

The USD could pass 88 in the weeks ahead, but I expect it to make a hike up to 90 – 91.

A good way to play this move is to buy the PowerShares DB US Dollar Index Bullish ETF (NYSE:UUP).

If you’re feeling bold and seek to maximize your gain, you could buy shares in the Double Short Euro ETN (NYSE:DRR.IV). So if the euro drops against the dollar by 10 percent, you’d be up 20 percent.

This from Investment U:

Recall, in late March I predicted here the dollar was overdue for a rally. Ninety-six percent of you cursed me. The other 4% pocketed an easy 20% or so (more if you played the options market).

But after such a swift run – mind you similar moves in currencies typically take years, not months – is the dollar rally finally coming unhinged?

Legendary investor Jim Rogers seems to think so…

As he told Bloomberg News in a TV interview, he plans to exit his dollar holdings because he thinks the dollar “will go down a lot” and it is “going to lose its status as the world’s reserve currency.”

To which I simply respond, “Into what Jimbo?”

No other choice for a reserve currency exists. No matter how much other governments wish it were so.

The euro is frequently mentioned. But it’s depreciating in value. And there’s not enough liquidity to handle the demand. Plus, it’s still a prepubescent, experimental currency, not one governments can invest in with 100% faith.

Moreover, with two-thirds of foreign reserves already in dollars, it would take more than eight years to replace the dollar as the currency of choice.

So once again, I’m striking out on my own. (And I’m ready for the flood of fan e-mails.) While many pundits would like you to believe that the dollar rally will be short-lived, I completely disagree.

The dollar’s not done.

Today I offer up three more reasons why. And of course, three ways to play it…

Too Far, Too Fast? Hardly…

Keep in mind, currency rallies tend to be measured in years and months. Not weeks and days. In fact, according to Bespoke Investment Group, the average dollar rally lasts 489 calendar days. The longest rally on record lasted roughly 10 years.

While I don’t think we’re in store for a historic run this time, I do think the current rally has more legs (about another year based on the averages out of Bespoke).

Aside from no alternative world reserve currency, here are three more fundamentals in defense of the dollar:

Further Interest Rate Cuts
Foreign governments bought into the farce that was decoupling. As a result, they remained hawkish for way too long, keeping interest rates too high, at a time when they should have been cutting them to stimulate growth. And now they’re scrambling to catch up. They must make growth their first priority. So further interest rates cuts are inevitable, narrowing the gap with U.S. interest rates. And before long, perhaps the middle of 2009, we could be raising rates while other countries are still lowering.

Continued Deleveraging
As Mark Astley, CEO of Millennium Global Investments, a U.K.-based currency manager notes, “there is a pyramid of leverage” in the financial markets that will take considerable time to unwind. The half-frozen credit markets are only slowing down the process. As they thaw out completely, expect hedge funds and foreign banks to keep buying up dollars.

Uncertainty Reigns
Despite a new president, uncertainty remains in the markets. Or as UniCredit wrote in a recent research note, “We do not expect global recession fears to wane considerably.” And during times of fear and risk aversion, the dollar tends to outperform.

Bottom line, the current rally has plenty of room to run. If you dare to be contrarian, here’s how I recommend you play it…

Consider Pure Plays
For a pure play on the U.S. dollar – without trading the currency markets – I recommend the PowerShares DB US Dollar Bullish Fund (AMEX: UUP). It’s designed to replicate the performance of being long the greenback against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

Another strong choice is the EverBank* DollarBull CD. Available in 3-, 6-, 9- and 12-month terms, it offers potential appreciation in the U.S. dollar against a selected foreign currency. If you opt for the latter, I recommend going long the U.S. dollar versus the euro.

Take Profits on Unhedged Multinationals
Consider taking profits in multinationals with significant foreign currency exposure. I say that because the rapidly strengthening dollar will dent future earnings in two major ways. First, because profits earned abroad will be worth less, as they’re translated back into dollars. Second, because demand for the company’s products will drop off, as they will be more expensive to foreign buyers. We’re already seeing this double-whammy hurt third-quarter results for some big multinationals. But if the dollar holds its ground, or strengthens further, the impact will be much more dramatic in the fourth quarter. So get out while you’re ahead.

Buy American
While the dollar was plummeting it made sense to buy companies with significant international sales. They provided a nice currency hedge. However, a strong dollar means we need to reverse course and seek out companies with zero (or minimal) international revenues. I’d stick to solid companies in the utility, health care and consumer staples industries, as demand will remain steady no matter how long the recession lasts.

In the end, I know my dollar stance is contrarian. Or as many of you put it last time, “ignorant” and “completely out of touch.”

I’d add “profitable” to that list now. And I don’t expect this time to be any different.

Source: Jim Rogers is Wrong… The Dollar’s Not Done