A year ago, in the wake of the then-announced additional monetary easing measures by the Federal Reserve (which since sent stock prices on a rocket ride for the next nine months), many of our readers feared a major decline in the dollar was imminent. To add some balance to our site content, we asked Peak Prosperity contributing editor Charles Hugh Smith to argue the case for a strengthening dollar. He graciously accepted, and in the year since writing Heresy and the US Dollar, America's currency did indeed strengthen notably vs. its fiat counterparts. Now, after the Fed's announcement of QE3 (plus), many of us are girding once again for dollar weakness. So we've invited Charles to once again play devil's advocate.

If you have not yet read Part I: Welcome to the Era of 'Ugly' Inflation, available free to all readers, please click here to read it first.

In Part I, we covered “beautiful deleveraging,” the goal of which is to systemically distribute the financial pain so the Status Quo is left intact, and the threat to this strategy posed by “ugly inflation.”  The critical difference between “beautiful” and “ugly” inflation is that incomes keep pace with the rising cost of goods and services in the former and are stagnant in the latter.  In ugly inflation, households’ discretionary income declines, reducing consumption, slowing investment, and crippling future borrowing.  Defaults rise; consumption, tax revenues, and lending decline; and the economy enters a self-reinforcing feedback loop of contraction.

This is the position the U.S. economy is in, as real household income has declined 8% since 2007 and inflation officially bubbles along at 2-3% (and at a higher rate for many essentials).

The Status Quo attempt to painlessly inflate our way out of over-leveraged indebtedness has run up against limits that are not apparent in a strictly financial model like Ray Dalio’s “beautiful deleveraging.” If we understand these other forces and tipping points, we will understand why central-bank deleveraging will fail.