Since peaking more than six years ago versus the world’s major currencies, the U.S. dollar has posted some dizzying declines. Only a few currencies in the world have actually declined vis-à-vis the sad buck since late 2001 – including the Zimbabwe dollar. That’s hardly a feet to be proud of considering hyperinflation has gripped the economically ravaged African nation over the last 12 months accompanied by 1,000% inflation.

There’s no doubt that since Nixon broke the gold standard in August 1971 the dollar has plummeted versus the world’s hardest currencies, including gold. Bulging trade and budget deficits, protracted military conflicts, bloated entitlement program spending and lingering financial institution bail-outs amid the ongoing credit crisis bode badly for the dollar longer term.

Indeed, you might say it’s the “beginning of the end” of American financial hegemony as long-term inflation erodes the dollars’ purchasing power and buys less which each passing decade. After all, to finance its enormous expenditures the United States, which is a reserve currency, prints its way out of financial turmoil by expanding the money-supply and growing inflation. The latest financial debacle since August 2007 promises to pile on even more debt, including toxic securities on the Federal Reserve’s balance sheet.

As the years progress, the United States will become even more dependent on foreign governments and institutions to finance its daily consumption, currently running at roughly $2 billion per day, courtesy of international lenders.

But bear markets are interrupted and investors should recognize short-term investment opportunities as a result. That’s exactly what’s happening now with the dollar.

Bull Market or Bear Market Rally?

The tables have turned against global currencies since August 8 when Germany’s mighty economy contracted in the second quarter, triggering one of the biggest dollar rallies in years.

Heading into August, the dollar was down almost 7% versus the euro; but it now trades virtually unchanged since the beginning of the year after hitting an all-time low in July. The buck is also running hard versus other currencies, including the resource units and even Asian currencies.

This current bout of dollar strength has more to do with the surprising weakness of other foreign economies than a resumption of U.S. growth; the market views the dollar as a leading currency as other economies begin to grapple with a slowdown or, in some cases, recession. The United States is aggressively priming the economy with interest rate cuts and fiscal measures to boost consumption, while the Europeans and Japanese only start to enter a slowdown cycle.

In the absence of interest rate hikes, budget cuts or a boost in real consumption under the weight of a credit squeeze and real estate deflation, it’s hard to make a long-term bullish case for the buck; but the market has shifted since early August as global investors embrace the undervalued dollar and the economy’s more compelling growth prospects into 2009 while other major economies sink. That’s giving the dollar a global edge now.

The Hunt for Dollar-based Profits

If I had to bet, the dollar is probably commencing a cyclical bear market rally. That’s exactly what happened in 2005 as the dollar rallied 12.8% versus the euro and other currencies. But in 2005, unlike now, the Fed was raising short-term interest rates after a period of ultra-loose monetary policy under former Fed boss Greenspan. This suggests any rally won’t last very long unless foreign economies deteriorate rapidly while U.S. growth accelerates.

There’s no doubt U.S. assets are cheap. That’s especially the case if you’re a foreign currency-based investor because the dollar is literally “On Sale” after years of double-digit declines since late 2001.

PIMCO Scoops Fannie and Freddie Debt

Some of the best values now lie in distressed mortgage-backed securities like Fannie Mae and Freddie Mac bonds. PIMCO, the world’s largest bond fund manager with over $800 billion in assets, has been aggressively accumulating the debt of both lenders.

Credit spreads for government mortgage agency debt has surged over the last few months and now trade at their highest levels in history compared to Treasury bonds. Premiums are now trading at just under 300 basis points or 3%.

The government has already guaranteed that both crisis-plagued mortgage lenders won’t fail. That means Fannie and Freddie debt is cheap at current prices while shareholders are likely to get wiped-out should the government eventually nationalize Fannie and Freddie.

Busted Properties

Real estate also offers excellent values, particularly from rising foreclosures and bank repossessions. This is exactly what occurred in the 1989-1991 Savings & Loans crisis; several years later, vulture investors earned big profits from buying cheap properties.

In the most devastated real estate markets of Nevada, Arizona, California and Florida, investors can find an abundance of residential and even a growing universe of commercial properties gone bust. To be sure, financing has grown more difficult for even the most creditworthy of borrowers as banks balk at lending. Yet, many deals will be closed over the next few years as banks grow increasingly desperate to unload a truckload of properties at fire-sale prices.

Real estate in the United States is also extremely cheap when priced in euros, yen or most other currencies. In 2007, more than 20% of all residential property purchased in Manhattan was by Europeans. I expect that trend to accelerate in 2008, especially if the euro continues to soften.

Watch Out for Foreign Markets!

Lastly, U.S. stocks offer big values compared to other markets because of the potential to earn organic returns in local currency while foreign markets lose their luster for dollar-based investors.

Over the last seven years, dollar-based investors have earned big profits riding the dollar’s decline combined with huge bull market gains in stock prices. But the opposite might occur now, similar to the 1995 to 1999 period, when U.S. markets outperformed.

A rising dollar has stripped U.S. investors of foreign market returns since late July. Global markets, of course, remain in a bear market since last fall and that includes the United States; since late July, foreign bourses, priced in dollar terms, have declined far more as an 8% surge in the buck adds insult to injury.

Therefore, I expect U.S. stocks to finally benefit from a surge in foreign institutional money after years of net outflows. I also think the huge inflows into foreign equity funds will slow markedly over the next 12 months as mutual fund investors redirect capital to domestic funds, which have badly lagged other markets.

The winds of currency change have arrived. I doubt this is the beginning of a secular long-term U.S. dollar bull market because all the preconditions for such a sustained rally simply don’t exist. Yet, a case can be made for the dollar over the near-term, as other economies trail the United States in the growth cycle and begin cutting interest rates. Lower rates abroad will weaken foreign currencies, and probably, most commodities and boost the value of financial assets (stocks and bonds) following a drubbing since the onset of subprime 13 months ago.