In the past four weeks, the dollar has surprised many people by staging a broad-based bounce. I wasn’t among them.

For more than two years, every time the dollar has turned down, there has been a groundswell of pontifications about itsimminent demise.

In the past few months, that sentiment was, perhaps, mostpervasive.

As certain as those zealots were who predicted the world would end last Saturday, so have been those who have predicted the end of the dollar.

But this type of frenzy and hysteria is nothing new. Not for the dollar, not for financial markets. In fact, it’s typical of every boom and bust trade. And it’s typical of every market that reaches a major turning point.

I was recently reading an old TIME Magazine article titled the “Shrinking Role for U.S. Money.” The date: October 1979.

Some of the outtakes read …

“Once again, greenbacks were being sold off heavily in world markets in exchange for more robust currencies.”

“As the dollar is being eased out of the cornerstone position it has held since World War II, gold and some strong currencies are moving in.”

A Bundesbank leader said the world is “moving inexorably toward a multicurrency arrangement.”

Sound familiar?

Also mentioned, a bestselling novel, The Crash of ’79, that laid out a tale of the destruction of all of the foundations of industrial society as nations returned to barter economies.

Measured against a basket of major currencies, the dollar bottomed in October of 1978, languished for about a year, and then proceeded to double in value over the next six years. Of course, there were major political and economic challenges at the time, and uncertainties along the way. But the point is, despite all of the panic and doomsday scenarios, the dollar didn’t go away! To the contrary, it remains the most important currency in the world today.All of this was written and said as the bottom in the dollar was already in place.

Fear, Greed and the Dollar

We have plenty of recent examples to reflect on where investor behavior can overpower all economic fundamentals. Many times, it’s driven by herding. By that I mean, often times overwhelming emotions of fear and greed can drive individuals to seek safety, or hope, in numbers. And we’ve seen plenty of that in recent years.

The same goes for the anti-dollar trade. And because markets in this environment have become so correlated, swinging between fear and greed, fearing a destruction of the dollar has also meant grandiose dreams of huge returns in contra-dollar assets (metals, other commodities, foreign currencies, stocks) — creating herding across asset classes.

Take a look at how heavily positioned against the dollar market participants were going into the first of May, as measured by the CFTC Commitment of Traders report.

You can see in the light blue shaded area of the chart below, the extent of positioning in the dollar.

Everything above the zero line on the right axis represents a market that is net long the dollar. Everything below that line represents a net short position. From that, you can see the net short position in the dollar was at its most extreme for this seven-year-plus window, coming into the month of May 2011.

You can also see how the dollar index (the dark blue line, measured by the left axis) tends to respond in these overstretched periods — where market participants are leaning so heavily in one direction: The dollar tends to revert, marking turning points. And in recent years, within the crisis era, these turning points have resulted in violent swings in the opposite direction.

I’m not joining the debate here about the inflation outlook, whether hyper-inflation, tolerable inflation, low inflation or another bout with deflation lies ahead. When it comes to currencies, it’s all about relative value.The Dollar—
Still the Best Alternative

Given the outlook for sovereign debt defaults to occur and spread across Europe, and for a dangerous slowdown on tap for Chinese growth, expect more and more global capital to move back into the dollar as the best, safest alternative.

My view: The dollar isn’t going away anytime soon. In fact, looking back over 40-years of cycles in the dollar, I expect it to have a sustained, strong rally over the next several years.

However, if you want to know about a currency that’s truly at imminent risk of going away, read my column from May 14 on the euro, the second most widely held currency in the world.

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