US dollar: Prepare for a prolonged devaluation

Those nagging whispers warning that the United States is heading for an Argentina-like currency crisis are getting louder. The prospect of a prolonged devaluation of the US dollar is just one more challenge in what has already been a difficult period for savers and investors. Have we really reached the point where the greenback is in danger of becoming an “also ran” currency?

The likelihood that the dollar will suddenly lose most of its value is remote. The economy would have to deteriorate to unimaginable levels for the dollar to fall to the depths of the Argentinean peso in 1999. However, this does not mean that the dollar is a risk-free investment. Quite the opposite, really, as there is a strong possibility that the dollar is mired in what could be a prolonged devaluation extending well into next year.

The credit crisis that triggered the Great Recession exposed several flaws in the US economy. The list of shortcomings includes economic growth too dependent on asset bubbles of one form or another, a workforce struggling in the face of greater international competition, and a long-held tradition of relying on deficit financing to keep the party going. The result? An economy – and a currency – in dire need of a correction.

This correction has already started as millions of unemployed Americans can attest. The Federal Reserve has conceded that unemployment will remain elevated through 2011. When employment does pick up, it is expected to do so at a much slower pace than experienced following recessions of the past.

Next week, the Fed is expected to intervene directly. Its Federal Open Market Committee can’t adjust interest rates downward because they’re already zero-bound. This leaves the Fed with only one option; additional stimulus spending in an attempt to inject more cash into the system.

Alas, just as in physics, every economic action has an equal and opposite reaction. While carpet-bombing the economy with excess capital increases liquidity, there is also the unintended side effect of further devaluing the dollar. And it may not be unintended.

In January’s State of the Union address, President Obama stressed the need to reduce the trade deficit. The last time the US recorded a trade surplus was 1975 and the president set a target of doubling exports in five years “because the more products we make and sell to other countries, the more jobs we support right here in America.”

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