In recent years, the performance of the USD has been dismal. The currency is near historic lows against most of the world’s major currencies (with the notable exception of the Japanese Yen), and in fact, just yesterday, the USD dropped to a 15-year low against the British Pound.  And yet, it is my belief that when all is said and done, the USD will have fallen much further in value.  You are probably wondering, ‘If the USD has already depreciated significantly, how could it still be overvalued.’

The answer is simple: the USD is currently suffering a correction relative to other currencies. Simply put, economic fundamentals and monetary benchmarks are becoming stronger in other countries, which is putting downward pressure on the USD, relative to other currencies.  The decline that I am presaging is a decline in the absolute value of the USD, which is more of a structural change in the USD than a financial or economic change. 

The primary driver of the decline of the Dollar is inflation. On the surface, inflation has been stable over the last decade, averaging about 3% per year.  There are a few things worth noting here. First, this statistics does not services for which prices are rising much faster than the general rate of inflation, such as taxes, education, and health insurance. Second, and perhaps more importantly, this statistic is net of the deflation that is wrought by inexpensive foreign-produced goods. In other words, if cheaper imports save us 3% annually, then domestic inflation is probably closer to 6%. When outsourcing the production of key goods and services no longer produces savings, then consumers can expect a rise in overall rate of inflation.

It should also be noted that since the stock market crash of 1929, the Dollar has lost 95% of its value, whereas in the previous 125 years, the purchasing power of the USD had hardly changed.  Meanwhile, the twin deficits (trade deficit and budget deficit) have ballooned, to the extent that the national debt now measures approximately $9 Trillion and the annual US trade deficit is fast approaching $1 Trillion!  The result is that the government has been forced to print tremendous amounts of new paper money.
This phenomenon is evident in US capital markets, where yields are anomalously low, credit spreads are non-existent, corporate earnings are at record levels, and there is a general excess of liquidity. 

The bright side is that this trend could be reversed if the government was able to balance its budget.  However, this is probably impossible since some estimates of the government’s future liabilities exceed $50 Billion, which would be required to plug the holes in social security and other government entitlement programs. Some sectors of the market have already sprung into motion: the price of gold, which is normally used to hedge inflation, has doubled over the last decade. Central Banks are formulating plans to diversify their foreign exchange reserves (i.e. get rid of USD assets as fast as possible before the currency depreciates further).