The state of the economy is tepid. President Bush gave a perfunctory push to his $674 billion tax cut plan during his State of the Union address, but it isn’t generating much enthusiasm. Democrats have devised a number of counter proposals for stimulating the economy, all with little effect. The fiscal stimulus has been substantial over the past year, but it will take months before Washington can legislate another fiscal package to further support the economy.

In the meantime, a government policy of benign neglect is bringing much needed support to the economy. The dollar is down by more than 15% on a trade-weighted basis since last March. The decline has accelerated over the past three months. A lower dollar should boost the international competitiveness of America’s beleaguered manufacturing industry.

The official government line is that a strong dollar is in the national interest. But no one in Washington seems too worked up about dollar depreciation. Besides the boost to manufacturing competitiveness, the greenback’s decline is nudging other nations to ease their monetary policies to keep their currencies from appreciating too quickly against the dollar.

On a more negative note, overseas investors seem convinced that the U.S. is no longer the place to look for lush asset returns. Little wonder, considering the U.S. stock market just finished its third year of consecutive negative returns, with the prospect of another down year looming. Investors are getting out of dollars and snapping up Euros, partly because European interest rates are higher and partly because the Continent is perceived as a safe haven while the U.S. prepares for military action against Iraq.

There’s the rub. War could turn the dollar decline into a rout, sending interest rates skyrocketing and equity prices plunging. Indeed, the day after Bush’s State of the Union speech the dollar fell in value against the Euro. The economy is extremely vulnerable to a dollar decline since America is so dependent on foreign capital. The U.S. current account deficit, the broadest measure of trade including investment flows, is the biggest it has ever been relative to the history of the last 200 years, according to economists at UBS Warburg. The concern is that war could spark a run on the dollar.

The mood in the financial markets is dark. But nowhere is the tension greater than in the world’s currency markets.

Exchange: Reactions to this week's "News and Views"? Discuss personal finance and the economy at the Sound Money Exchange.