To cut rates or not to cut, that is the question that Ben Bernanke and his fellow associates at the Federal Reserve must still be mulling over as the September 18, 2007 highly anticipated FOMC meeting looms ever closer.

There is ample evidence that a good dose of inflation, like an ill wind, is headed our way. For example take a look at this Commodity Research Bureau (CRB) Spot Index Chart that plots the index of 23 industrial commodities.

Then consider that we have wheat at record price levels. Gold is trading at over seven hundred Dollars an oz. There are record prices for crude oil at over $80 a barrel. Milk is at record levels as is the price of beef. I could go on but I’m sure that you get the inflationary picture.

If Ben Bernanke and company were to focus simply on the inflation outlook, the real inflation outlook, not the watered down official government one that excludes energy and food prices, they would not dare to cut interest rates at this time.

However, it is not as simple as that. The trouble originating out of the sub prime mortgage lending market and the resulting infection of troubles throughout the US housing market must be deeply troubling. With housing foreclosures already at record levels and with housing such an important part of the US economy some rate relief would seem to be in order.

The markets seem to have already priced in a 25 basis point reduction on the federal funds rate. Some analysts think that the discount rate will also be cut by 25 basis points. Others think a rate cut of 50 basis points is in order.

Clearly it doesn’t take a genius long to figure out which way the US Dollar has been headed for the past year. The sad fact is that if the US Dollar Index chart were for a longer time frame and showed the history of the Dollar for several more recent years it would only be more of the same.

Many analysis consider the 80.00 level on the long term chart as the critical level. A close below 80.00 would signal an acceleration of the trend. That close has just occurred.

There are definite signs that the rest of the world is getting tired of absorbing surplus US Dollars. As a fiat currency there is no sound backing for the tremendous number of Dollars now being printed by the US government.

China has hinted that they may not be so eager to keep purchasing US Treasury Bills and Notes. Russia is shifting out of Dollars into a more balanced foreign exchange portfolio. A Japanese oil company has started to pay for oil imports in Yen, not Dollars. The Iranians now want Euros for its oil, not US Dollars.

The list is growing. And why not? No one or no nation wants to keep absorbing at their risk an asset like the Dollar that is headed South.

Watch out for the acceleration of the downtrend. That will destabilize world financial markets and possibility drive the world economies into deep recession or worse.

See this chart and many others such as the S&P 500 and the CRB Index at Ino.com

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The Euro made all time highs against the US Dollar today reaching 139.11 just before noon during the New York time period. A cup of coffee in London is well over $5.00 at those rates. If you are an American traveling in Europe these days you had best set up a substantial line of credit prior to departure.

The Dollar looks to be near a complete collapse. Forex market participants fear that additional problems in the sub prime housing mortgage market are going to hurt the overall economy. There is the perception that in an effort to bail out the housing market the Federal Reserve will cut the key Fed Funds rate by as much as 50 basis points at the September 18 FOMC meeting.

A cut in interest rates in the US will keep further pressure on the Dollar. It really is a lose, lose, situation for the Fed.  Inflation is picking up but to attempt to curb it interest rates must remain at current levels or even be mover higher. Yet conditions in the housing market are obviously getting worse and lower interest rates may help to control the damage. Either way, cut rates or leave them unchanged, there is going to be a price to pay.

Confidence in the Dollar is falling worldwide. There are indications out of Russia and China that both nations are shifting their allocation of foreign exchange holding out of Dollars. One really can’t blame them as it make little financial sense to earn a 5% interest rate while exposed to a currency risk that over the past year has cost about 20%.

The US “Jobs Jamboree” report released by the US Department of Commerce this Friday, September 7th was a real shocker to the so called experts. While the pre-release consensus guesstimate figure was for the addition of 100,000 jobs for the month of August the actual figure was a minus 4,000. This was the first time in four years that job growth was reported as being negative.

The Dollar immediately sold off hard on the news as speculation mounted that the Fed will cut interest rates by a full 0.50 basis points at its September 18th meeting. The Federal Reserve is in a no win position at this time. A cut in the Fed funds rate may help Wall Street but it certainly won’t help the Dollar which is already under a lot of pressure. And a collapsing Dollar given the extend of carry trade financing that will come unglued as especially the Yen gains strength can not possibility be favorable for the stock market.

There is likely major trouble coming next week for the Dollar and the stock market. The Yen gained over 200 pips today against the Dollar, finishing the week out at about 113.37. This was enough of a move that will force additional carry trade liquidation.

The important thing to remember about forced liquidations is that those forced to liquidate, like hedge funds, are finding there is no real market for their portfolios of funny money marked to model derivatives of which they are holding billions. The smart guys have outsmarted themselves.