On a day when the United States committed up to $2 trillion more in government financing and programs to unlock credit markets -- probably the federal government's largest, one-day implied commitment in history -- the dollar rose against the euro and British pound.

The dollar strengthened 1.2 cents to $1.3821 and a gargantuan 4 cents to $1.4488 versus the British pound. The dollar also rose about one-half cent to $1.1584 versus the Swiss franc.

Now, in theory, increasing dollar commitments by the U.S. government means more dollars in circulation, which means every dollar is worth less -- a sequence that should cause the dollar to fall against the world's other major currencies. Not Tuesday, and really, when you review it, not since the financial crisis took hold in October 2008, so says economist David H. Wang. And the reason is basic: the dollar's status as a reserve currency, and as a safe haven.

The previous U.S. presidential administration preached a great deal about a 'strong dollar policy.'

Unfortunately, almost no actions practiced by the administration supported that goal.

Concerning the federal budget, a decade of deficits has really hurt the dollar's value. A $1.3 trillion tax cut in 2001 ended the balance budget era of the late 1990s, and subsequent increases in defense spending for the Iraq and Afghanistan Wars -- combined with a lack of a tax increase to pay for that additional spending -- soon led to +$200 billion budget deficits. After swelling to $300 billion, the bank bailout and related legislation would push the deficit over $500 billion, according to the Congressional Budget Office, and it's projected to top $1 trillion this year and in fiscal 2010.

The dollar, despite the prospect of back-to-back trillion dollar U.S. budget deficits, continues to hold its own against the world's other major currencies. What's more, provided the fiscal stimulus package is passed, the national debt ceiling will increase to $12.1 trillion from the current $11.3 trillion.

The dollar strengthened about 1.5 cents to $1.2867 versus the euro Wednesday, and rose about 1.4 cents to $1.1586 versus the Swiss franc, while remaining essentially unchanged at 89.62 yen and $1.4490 versus Japan's yen and the British pound.

When financier George Soros makes a play, traders stand up and take notice. In 1992, Soros made $1 billion by selling the British pound.

Recently, he used the same strategy of betting against the pound. However, when the pound traded below $1.40 last Wednesday, Soros decided to cover his short position. The pound has traded up to $1.4256 against the dollar on Friday. As demand for the pound rose, it had the effect of putting pressure on the U.S. dollar.

The U.S. dollar is considered a "safe haven" currency because it is the world's reserve currency. The Dollar Index contract is traded on the New York Board of Trade. It is traded as a single currency but the actual value of the dollar is based on a basket of currencies. What does this mean in actual trading? Traders usually decide to buy or sell a given currency based on the strength or weakness of the underlying economy for that currency. So when we see a headline: "Pound hits 23 year low on Dollar" it means that on a relative basis the pound is weaker than the U.S. dollar.

You could infer from this headline that the British economy is weaker that the U.S. economy and is the reason why the British pound is the weaker currency.

Trading in the currency markets, however, is not always as clear cut as this example. A host of complex variables go into determining a country's currency including the country's political and financial structure, who the leaders of a given country are and most important what is actually happening within that particular country's economy.

These days, the only thing worrying the economists and analysts more than the U.S. economy is the United Kingdom economy.

The U.K.'s situation is worrying currency traders, too. The dollar vaulted 5 cents Tuesday versus the British pound to $1.3890 -- an almost unprecedented move in the currency market -- as traders sensed a deepening recession in the U.K.

The dollar also strengthened 1 cent versus the euro to $1.2940 and 1.2 cents versus the Swiss franc to $1.1422. The dollar was essentially unchanged versus the yen at 90.45 yen.

Currency Trader Andrew Resnick told BloggingStocks Tuesday that with the United Kingdom's decision Monday to allocate an additional $142 billion to support the nation's banks, currency traders "have put the British economy in a time-out chair."

The U.S. Federal Reserve continues to expand its balance sheet. Further, the U.S. government is piling on debt and public borrowing at almost a faster rate than Mexico and Argentina did during "the bad old days" decades ago.

And yet the dollar continues to hold its own against most of the world's other major currencies. The dollar strengthened about 2 cents against the euro and British pound Tuesday at mid-day, to $1.3190 and $1.4538, respectively. Just as significant, the dollar has strengthened about 11% versus the euro and about 22% versus the pound since October 2008.

Big factor: first in, first out

What's going on here? BloggingStocks asked economist Peter Dawson to provide some clarity.

"Three factors are at work. Most important is the economic cycle. The U.S. was the first to enter a recession and it will likely come out of it sooner than Europe and the U.K., so that's supporting the dollar," Dawson said. "Second, there's still considerable flight-to-safety by stock-shy investors, which almost always increases purchases of U.S. Treasuries, another dollar plus."

What's one possible consequence of the major interventions by the U.S Federal Reserve and U.S. Treasury?

The dollar's safe-haven status may end, or at least diminish as the increased dollars in supply lowers the dollar's value and perhaps increases inflation.

On Wednesday, the dollar fell after the Fed Tuesday cut its key, short-term interest rate by 75 basis points to a targeted 0.00%-0.25% basis point range, and also said it would continue to use non-traditional techniques to keep markets liquid. The dollar weakened about 1 cent to $1.4094 versus the euro, about 2 cents to $1.5353 versus the British pound, and about 1.6 cents to $1.1076 versus the Swiss franc. The dollar also fell about one-half yen to 88.46 against Japan's yen.

In one scenario, low interest rates, a recovering global economy and a re-emergence of risk appetite drive institutional investors out of the dollar in favor of stronger major currencies, such as Japan's yen and the Swiss franc. The U.S.'s rising budget deficit also would weigh on the dollar.

However, the above scenario is not guaranteed, so says economist Richard Felson. Under a different scenario, the dollar weakens somewhat on the aforementioned lower interest rates and liquidity actions, but then the dollar firms and rises, as the U.S. economy recovers before the European and Asian economies do.

The dollar and British pound continued to trend lower Monday, as investors large and small once again emphasized the impact of recessions on both continents, and the U.S.'s rising budget deficit.

The dollar fell about 2 cents to $1.3598 versus the euro and about 1 yen to 90.42 versus Japan's yen. Meanwhile, the euro rose 2 pence to 90.10 pence versus the pound.

Economist Richard Felson said the dollar, which prior to last week appeared to be immune to the extra dollars in supply stemming from U.S. Federal Reserve's interventions and U.S. Treasury's TARP borrowing for the bank rescue, now may start to experience the harsher light of day.

"Investors appear to be reassessing how much the dollar will decline as we grapple with the financial crisis and the recession. Earlier, the consensus was that stock, housing, and asset price falls would offset dollar infusions by the Fed and Treasury, but now the calculus appears to be changing," Felson said. "But dollars don't appear to be in short supply right now, and that then turns the focus to the U.S.'s poor economic fundamentals, which is leading to dollar selling."

Further, poor economic fundamentals are at the core of the British pound's slide versus the euro, Felson added. "The pound is being weighed down by weak economic data, risk aversion, and the conviction that the United Kingdom will experience a deeper recession than the European Union, with a broader and longer-lasting housing slump in the U.K.," Felson said.

Crises have a way of separating strong business models from sub-par ones. Similarly, they sometimes invalidate theories institutional investors and economists have adhered to for generations.

One example of the latter concerns the dollar. The Federal Reserve's balance sheet has increased to $3.5 trillion from $800 billion in September. Meanwhile, the U.S. budget deficit for fiscal 2009, will likely exceed $550 billion (pdf) and could top $1 trillion; it could top $1.2 trillion next year.

Had the aforementioned debt increases occurred in Brazil, Mexico, or Argentina, the result would have been a flight of international investors out of local investments, accompanying respective currency runs, and an ensuing domestic crises.

The impact of the increased debt on the United States? By almost all measures, it's been mild. Since September, the dollar has risen about 15% and 20% against the euro and British pound respectively. Meanwhile, borrowing costs for the U.S. government have trended lower, with interest rates on the 10-year and 30-year bonds falling to 2.79% and 3.29% respectively.

True, the dollar has fallen 13% versus Japan's yen, as institutional investors, unable to productively invest borrowed, low-interest-rate yen, returned that money to Japan, but by and large the dollar has remained firm amid the nation's worst financial and economic crisis in at least 40 years.

Many economists had expected the dollar to weaken. Economist Peter Dawson was one of them.

Despite the prospect of a more than doubling of the U.S. annual budget deficit for each of the next two years, the dollar has held up reasonably well so far against the world's other major currencies, actually rising against the euro and British pound, while falling against Japan's yen.

But a commodities guru says that won't last.

Commodities expert Jim Rogers says U.S. policy makers will devalue the dollar, undercutting the greenback's reserve currency status, according to Bloomberg News.

"They think that if you drive down the value of your money, it makes you more competitive, now that has never worked in history in the long term," Rogers said. He added that he is buying Japan's yen and started buying commodities, such as sugar, in October, calling low commodity prices "astonishing." (For full currency data, click here.)

Still, despite Rogers' superior performance predicting commodity cycles -- in 2006 he correctly predicted that oil would hit $100 and gold $1,000 -- not every economist is in agreement with his dollar devaluation thesis. Economist David H. Wang said that while the dollar will likely decline in value some, due to increased U.S. government borrowing, that does not guarantee a decrease in U.S. competitiveness.

From fiscal and economic fundamental standpoints, this is something that shouldn't be happening. Or at least it wouldn't be happening in normal times.

But as investors know, and as currency traders will quickly point out, these are not normal times.

Safety is paramount

The dollar continues to hold its own, for the most part, versus the world's other major currencies, despite the fact that the United States is likely to bear the largest economic and fiscal costs stemming from the financial crisis and consequent recession. The dollar has held on to gains recorded earlier in the month against the euro and the British pound, at about $1.2670 and $1.4720, respectively, losing ground only against Japan's yen, at 96.60 yen.

Currency Trader Andrew Resnick said the dominant theme in the currency markets -- as in almost every market these days, it seems -- is risk aversion and a flight-to-safety.

"The dollar is clearly benefiting from the flight-to-safety. On an economic fundamentals basis, the dollar should not be this strong and U.S. interest rates should not be this low, but fundamentals are not ruling the day now," Resnick said. "Safety and the protection of capital is." Resnick added that he was presently flat, or had no open currency positions.

The dollar and yen surged Friday -- with the yen the clear winner head-to-head versus the dollar -- as traders and institutions added both currencies in a flight-to-safety on concern that all of the world's major economies will fall into a recession at the same time.

The dollar surged 3 cents versus the euro to $1.2642 and 6 cents versus the British pound to $1.5606.

The yen strengthened 4.7 yen to 92.64 versus the dollar and about 10 yen to 144.73 yen versus the British pound.

Institutions raise cash in dollars, yen

Currency Trader Andrew Resnick told BloggingStocks Friday, this morning's flight-to-safety is not solely due to economic fundamentals, which suggest slowing growth in the world's major economies, but also hedge fund / investment fund de-leveraging and closing out of losing stock positions.

"We're seeing many things happen at once, and that's producing these enormous moves. First, the carry trade [where traders borrow yen and invest it elsewhere] is unwinding. Leverage for investing purposes is declining as a trading strategy," Resnick said. "Second, major players are raising cash to cover redemptions, which is also causing stock markets globally to plunge."

"Third, we're seeing a re-pricing of risk to the higher, which is forcing some funds to raise even more cash, boosting the dollar," Resnick said. "Some of the moves are cash-necessary moves, but many are clearly panic-based, with traders exiting positions that have little chance of succeeding if the global economy continues to slow."

Here's an icebreaker for your next cocktail party or dinner party. (This one is sure to impress your friends and colleagues even more than explaining the market and economic significance of credit default swaps.)

Q: What's the strongest currency in the world?

Well, let's evaluate the world's major currencies and hone in on the answer.

• The dollar -- For the last few decades, the dollar was the world's strongest currency. After all, it is the world's reserve currency. However, recent history has not been too kind to the dollar -- the dollar's value has declined throughout the decade -- and the near-term outlook does not look good, either. Massive government spending to both end the financial crisis and put the U.S. economy on a sustainable growth track means additional inflation, if not dollar devaluation, is likely. Nix the dollar as the world's strongest currency.
  

• The British pound -- At one point in history, the sun never set on the British Empire, and the pound was the world's reserve currency. Although the pound has been strong this decade, likely additional interest rate cuts and fiscal stimulus to jump start the economy of Her Majesty's Kingdom, as John Lennon would refer to his native land, means the pound is likely to lose value in the year ahead. Nix the pound as the world's strongest currency.
  

• The euro -- The euro has challenged the dollar for reserve currency status this decade, and has gained versus the buck for most of that time, but you guessed it: the heavy hand of the financial crisis is beginning to take a toll. For example, Germany alone has approved a 650 billion euro (or $500 billion) bank rescue plan. That's equivalent to the U.S. putting in place a $2.5 trillion plan. Wow. Let's hope Germany doesn't have to use most of it. Of course, the euro zone is more than Germany, but severe stagnation in Germany suggests several more interest rate cuts by the European Central Bank. Nix the euro as the world's strongest currency.

Now one would think that the dollar, viewed as the source of much of the world's commodity price inflation this decade, rising from long-term lows would be a cause for celebration.

Not exactly.

While the dollar's rally against most of the world's other major currencies does mean commodity price pressures are likely to continue to subside -- and that's good news for inflation, economists say -- the dollar is nevertheless rising for the wrong reason. Namely, an economic slowdown in Europe.

Euro, pound plunge on recession concerns

"It's not so much as the dollar is strengthening but that the euro and pound are weakening on the likelihood that central banks in Europe will have to cut interest rates more to deal with a recession," economist Peter Dawson said. "Europe is also seen as later in the business cycle than the U.S., which means the U.S. economy is likely to recover sooner, which also helps the dollar. "