What to make of the recent suggestion by China's central bank that the U.S. dollar should be replaced by a new reserve currency?

Two words: fat chance
It's an intriguing idea -- details on that in just a bit -- but a funny thing happened shortly thereafter. When Treasury Secretary Tim Geithner seemed to momentarily countenance the notion late last month, the dollar swooned, dipping dramatically before Geithner walked his "reasonable, it's-worth-considering" response all the way back to the currency-traders' happy place. Additional reassurance later in the day also comforted the dollar market.

All told, despite the fact that implementing such a move could doom the dollar, the stock market rose throughout all this back and forth … and back. Shares of companies that rely heavily on foreign suppliers such as Wal-Mart (NYSE: WMT) and Home Depot (NYSE: HD) posted decent gains on the day. Shares of more export-oriented companies like, Dow Chemical (NYSE: DOW), Weyerhaeuser (NYSE: WY), and PepsiCo (NYSE: PEP) also did very well. That's telling, I think, with the market (in part) performing weak-dollar math and pricing in the likelihood that these companies' goods could become more attractive abroad.

How's that again?
Currency arithmetic seems -- and in some respects is -- exotic. Still, the basic principle behind the dynamic sketched above is straightforward. Let's say there's a 1:1 relationship between the U.S. dollar and, um, the Freedonian groucho. If a U.S. exporter wants to sell a $100 item into the Freedonian market, the purchaser there will have to pony up 100 grouchos to seal the deal.

If, however, the dollar slips and becomes worth, say, just $0.90 relative to the groucho, that's effectively a 10% price cut.

You can see how this would work in reverse, of course, with the products we import becoming more expensive as the dollar grows weaker. And also of course, we are (and have been) on an importing bender, with 2008's trade deficit -- a figure that sums the dollar difference between the goods and services we purchase from abroad and those we sell overseas -- weighing in at a fat and unhappy $680 billion.

Which, of course, is why the dollar is doomed.

Doomed, I tell you!
Despite an impressive bear-market rally over the last six weeks or so, almost nothing fundamental has changed about our big economic picture. Unemployment remains around 8.5%, consumer confidence, personal income, and spending remain moribund, contributing to what is becoming bout of deflation. Business spending is also comatose, and after showing some promise, retail sales have recently disappointed, coming in well below the market's expectations last week.

A sagging economy, combined with massive recovery spending and a large trade deficit is likely to weigh on the dollar.

That's not necessarily a bad thing ...
A weaker dollar would make U.S. goods more attractive both at home and abroad, benefitting domestic companies with significant exports such as Proctor & Gamble (NYSE: PG) and Apple (Nasdaq: AAPL).

Combined with the government's outsized spending plan, such a move would pack a one-two punch to pull us out of this looming deflationary spiral and lead, eventually, to a virtuous cycle: increased spending begets increased production, which begets increased job creation, which allows for more spending, leading to increased production, which leads to ...

Well, you get the picture
You can bet the authorities tasked with repairing this economy are aware of these dynamics. China's artificial low-yuan-strong-dollar policy has been criticized for years for wreaking havoc on our trade deficit, and the administration recently backed off on its prior criticism, in part because China has finally allowed the dollar to depreciate. Continued...