Everything you need to know about the Bush administration's dollar policy was encapsulated in Treasury Secretary John Snow's trip to Europe last November. Snow, in a typical speech, told the Royal Institute of International Affairs in London that "our dollar policy remains unchanged, because a strong dollar is in both the national and international interest." But, he also insisted, the Bush administration is a firm believer in letting "market forces" determine the dollar's value. "The only way to get prosperity is to follow the marketplace," he said. The marketplace knew exactly how to interpret Snow's remarks. Following his London speech, the dollar fell to a five-year low against the euro, and it continued to slide for the next six weeks.

Saying that Americans live beyond their means has become something of a cliche. But, as a diagnosis of the dollar's recent malaise, it happens to be exactly right: We import more than we export; we spend more than we save. To make the numbers add up, the rest of the world has to accept a growing supply of dollars. As happens whenever the supply of something increases without a corresponding rise in demand, the value of the dollar has fallen.

Snow knows as well as anyone that there are two ways for the U.S. economy to adjust. First, the dollar can keep losing value until foreign goods become prohibitively expensive and American goods became cheap. This would depress U.S. imports, stimulate exports, and bring the current account deficit back into balance. It also has the virtue of being a relatively painless solution to the underlying problem. The alternative is that Americans can consume less and save more. This would, of course, require some short-term sacrifice. For example, the most obvious way to increase national saving would be to lower the federal budget deficit, currently hovering above $400 billion per year.

In principle, either method can work. In practice, though, once currencies begin to adjust in response to economic imbalances, they often overshoot their targets. The only force restraining them is the belief among investors that the imbalances are being addressed. Absent that reassurance, a gradual dollar slide could easily turn into a rout. Interest rates would spike, the value of the stock market would tank, and the economy would veer toward a deep recession.

Is there any evidence the Bush administration understands this dilemma? None that we can see. Just about every pronouncement the White House has made since winning reelection betrays a blithe disregard for the consequences of the deficit. It has hinted at a proposal for the partial privatization of Social Security that would run up $1 to $2 trillion in new debt over the next decade. It initially attempted to exclude the costs of ongoing operations in Iraq and Afghanistan from its own measure of the deficit. And it has insisted that the baseline for its promise to cut the deficit in half by 2009 is its February 2004 estimate of $521 billion rather than $413 billion, the actual 2004 deficit. (The higher baseline makes halving the deficit roughly $50 billion easier to achieve.)

Unsurprisingly, institutional investors and foreign central banks, the chief holders of U.S. Treasuries, are not buying it. Literally. Speculators are increasingly bearish on the dollar. Even the famously conservative Warren Buffett has plunked down a $20 billion bet against the greenback. Meanwhile, Russia and Indonesia both announced late last year that their central banks may soon begin diversifying into euros. And, just this week, a survey by the London- based Central Banking Publications found that foreign central banks are increasing their euro reserves, most of them to offset lower dollar holdings.

The administration's defenders argue that the dollar can't fall too far: The sheer magnitude of the U.S. economy makes the dollar the de facto currency of international commerce and finance. But the rising prominence of the euro means the dollar is no longer irreplaceable. The Eurozone increasingly rivals the United States in its share of global output, a trend that will only continue as it expands to include countries like Poland and Turkey. And, thanks in part to anti-Americanism (another signature Bush administration achievement), major oil producers may soon begin pricing their exports in euros.

In mid-December, the president told reporters, "We'll do everything we can in the upcoming legislative session to send a signal to the markets that we'll deal with our deficit, which, hopefully, will cause people to want to buy dollars." But, judging from Bush's record so far, "everything we can" means not very much, and a policy based on hope is really no policy at all.

This article originally ran in the February 7, 2005 issue of the magazine.