Pity the once-mighty greenback. Back during the Clinton years, treasury secretaries Robert Rubin and Lawrence Summers ceaselessly intoned the mantra “A strong dollar is in our national interest,” and the markets cooperated by driving its value against the major foreign currencies steadily higher. That momentum continued through the first year of the Bush Administration.

But for the past three years, the film has been running in reverse. Bush’s hapless treasury secretaries, Paul O’Neill and John Snow, have tried intoning the mantra, but with little conviction and no cooperation from the markets. Between the February 2002 peak and the December 2004 low in the value of the dollar, our currency lost 35 percent of its value against the euro, 22 percent against the Japanese yen and even 24 percent against the Canadian dollar. The greenback rallied weakly for the first several months of the year, but the gain amounted to no more than a few percentage points.

Why? And does it matter to those of us who aren’t invested in currency strength as some kind of phallic symbol?

The major reason for the dollar’s weakness is the profound imbalance in America’s dealings with the outside world: We import far more than we export. The trade accounts slipped into the red in 1976, and the deficit has been getting steadily larger. This is an unusual performance for a rich country, where rough balance or even large surpluses are the norm. Trade deficits are usually associated with countries undergoing impressive growth spurts, like South Korea in its glory days (though the country has since matured into surpluses)–or chronically troubled economies, like those of Africa or Latin America.

When imports greatly exceed exports, you must borrow vast gobs of money from abroad to make up the difference. During the late 1990s, most of our foreign money came from private investors, intoxicated by the New Economy miracle of the Clinton era. Lately, the task of financing American deficits has fallen to the central banks of Asia, whose dollar assets (mostly US government bonds) now collectively surpass $1 trillion. They acquire these dollars in two ways. First, when Americans import foreign-made goods, we pay in dollars, which then accumulate abroad. Since there is relatively little that we export to Asia, they don’t spend those dollars on our products; they acquire our securities instead.

And second, in an effort to keep the value of their currencies from rising against the dollar, which would raise the price of their exports, Asian central banks, especially China’s, have been selling their own currencies. When they sell their own currencies, they get dollars in return–dollars that are invested in obligations of the US government and related entities. As a result of these defensive operations, China has successfully kept the value of its currency, the yuan, unchanged against the dollar–and kept Chinese exports growing mightily.

This gusher of borrowed money–$2 billion-$3 billion of it every business day–has gone to finance Bush’s budget deficit and to cover US consumers’ penchant for buying stuff on credit. But instead of relying principally on their credit cards for the borrowed money, for the past several years consumers have been borrowing massively against the rising value of their houses (more than $2 trillion since 2000). The ultimate source of those borrowed funds: Asian central banks.

For a long while, it didn’t matter. The President was too busy acting tough to notice that he was doing so on someone else’s dime, and the financial markets didn’t worry much either. The market tone has changed in recent months, though, as worry mounts. Occasional indiscreet remarks from Asian politicians about “diversifying” out of dollar assets have provoked brief market panics. But Federal Reserve officials profess not to be concerned; in a remarkably complacent speech delivered March 11, Alan Greenspan essentially argued that rising US foreign debt wasn’t a serious problem because it hasn’t proved to be one yet.

Maybe Greenspan’s right–though it’s disconcerting to recall he spent much of the late 1990s arguing that the stock market wasn’t in a speculative mania. It’s possible that the dollar’s decline against major foreign currencies will boost our exports and discourage imports, thereby diminishing the trade deficit. But our trade deficits with Europe, Japan and Canada have widened despite large shifts in the exchange rates. Though this is counterintuitive, and surprising even to orthodox economists, the reason may be that we don’t make much that anyone wants. And the dollar hasn’t declined at all against the Chinese currency. The stickiness of the yuan, and the persistent trade deficit with China, has fired up some nationalists in Washington who want to force China to revalue its currency or face punitive tariffs. Such a policy could be very dangerous, threatening global trade and financial flows (and thereby risking global recession) while doing nothing to address our underlying industrial weakness or the American penchant for living beyond our means.

So far, the dollar’s swoon has been orderly. But the risk is that the central bankers will decide that they’re holding too many dollars–or hyperemotional market participants will surmise that the central banks are about to come to that conclusion–which could provoke a cascade of panic. Investors, domestic and foreign, would dump their bond holdings, causing an interest-rate spike. That spike would send the stock market into a tailspin; stockholders hate rising interest rates. (There are several reasons for the hatred: Higher interest rates raise the cost to professional speculators of borrowing money, they increase the attractiveness of bonds as investments relative to stocks and they generally portend an economic slowdown.)

Markedly higher interest rates would almost certainly knock the stuffing out of the housing market, ending the wonderfully stimulative game of borrowing against home equity, and tip the broad economy into recession. All those millions who’d borrowed energetically on the assumption that interest rates would stay low and house prices would keep rising would find themselves deeply “embarrassed,” to use the quaint nineteenth-century term for busted.

That economic unraveling is similar to what happened to countries like Mexico and Thailand when their imbalances reached the breaking point. And the orthodox prescription for a country running huge trade deficits is a deep recession, since a slump would lead to a serious decline in imports. But the United States isn’t Mexico or Thailand. We’ve gotten away with levels of foreign borrowing that would have sunk an ordinary country. Can our luck continue?

It could, but it’s not very wise to bet on that. Even if the worst doesn’t come to pass, it’s still quite possible that some milder version of the crisis scenario could exert a drag on employment and incomes for years. There are things we could do to insure against the crisis or crisis-lite scenarios, like reversing Bush’s tax cuts and rebuilding our manufacturing capabilities. Neither seems likely right now. So let’s root for luck– it’s about all we’ve got.