From February 2002 to July 2003, the U.S. dollar fell by more than 18 percent against major currencies, according to the U.S. Federal Reserve. This elated U.S. exporters, whose products have became less expensive and more competitive abroad. On the other hand, the weaker dollar hurt importers, who must pay more for foreign goods.

Whether you deal in U.S. dollars or foreign currencies, you need to protect yourself against adverse fluctuations.

How Currency Shifts Affect Business

When the U.S. dollar fluctuates in value against other major currencies, global trade flows, as well as a company’s level of international competitiveness, are impacted. For example, in the seven-year climb leading up to February 2002, the value of the U.S. dollar rose by 40 percent. This pushed the cost of U.S. goods and services beyond the reach of many overseas buyers, resulting in fewer U.S. exports. The exceptionally strong dollar forced U.S. producers to increase productivity or cut costs in order to remain internationally competitive.

A weak or declining dollar, however, has the opposite effect. As the value of the dollar decreased from its recent high in February 2002 through July 1, 2003, the cost of U.S. exports in terms of many foreign currencies became 17 percent less expensive. This allowed foreign buyers to obtain more for their money — making U.S. goods and services more attractive. As a result, U.S. exports should increase.

But, U.S. companies interested in purchasing foreign assets will receive less for their money. However, U.S. firms already invested abroad will generate larger profits when converting their foreign currencies to dollars.

The Nearly Impossible Task of Managing Currencies

Today, new sophisticated technology allows investors to transmit tremendous amounts of capital to all corners of the globe with unprecedented speed. This is affecting assumptions about financial controls. The belief that national governments or central banks — in both developing and developed countries — can still manage their capital outflows or currency fluctuations to the same degree as in the past is dangerous and has resulted in extensive economic instability.

This is exemplified by the Asian financial crisis that began in 1997, Mexico’s peso crisis that began in 1994 and, to a lesser extent, Great Britain’s and Italy’s withdrawal from the European Exchange Rate Mechanism in September 1992.

The Risks and Rewards of Accepting Foreign Currencies

The exporter’s ability to offer attractive terms to foreign importers can create a much needed edge over the competition. Accepting a foreign currency for payment is one way to achieve that goal. However, adverse currency fluctuations can eat into the exporter’s profits or cause a loss.

For example, if a U.S. manufacturer ships $100,000 worth of goods to a foreign buyer with payment due in 90 days in the foreign currency, and at the end of 90 days the foreign currency loses 30 percent of its value, the U.S. exporter will lose $30,000. On the other hand, when currencies are increasing in value against the U.S. dollar — as in the case of the euro and Canadian dollar — the risks and rewards are entirely different.

The Rising Euro and Canadian Dollar

On January 1, 1999, when the euro was established, it was worth approximately U.S. $1.16. Over the years, its value dropped to about U.S. $.82, and registered approximately U.S. $1.15 on July 1, 2003. Its increase in value against the U.S. dollar has some analysts thinking the euro could eventually become the world dominant currency. According to the Conference Board, a research organization, 60 percent of world trade is currently denominated in dollars. In the event that the greenback falls from first place, a position it’s held since usurping the British pound after World War I, more global business will be conducted in euros. But regardless of which currency is on top, more and more European companies will request that their suppliers conduct business in euros.

The value of the Canadian dollar, one of the biggest influences on Canada’s economic growth, reached U.S. $.74 on July 1, 2003, up from approximately U.S. $.66 one year prior. Consequently, Canadian exports to the United States, now 12 percent more expensive than they were a year ago, are likely to decline. This means if you are accepting Canadian dollars for payment, you’ll receive 12 percent more value.

Projecting Shifts Is Problematic

Successfully managing foreign currency exposure requires an understanding and assessment of a variety of factors and conditions affecting currency volatility, including the following three important indicators:

  1. Macroeconomic fundamentals (economic growth, inflation, unemployment and balances of trade);
  2. Political considerations (upcoming elections, policies and the level of confidence in the government); and
  3. Social considerations (labor unrest and violence).

Nevertheless, in actively traded markets, the considerations and potential outcomes are infinite. As a result, managing foreign currency exposure often requires more than research-based predictions — it demands a sound hedging strategy.

Spot, Forward and Option Contracts

Through the use of spot, forward and option contracts, exporters can insulate their business, minimize losses and even take advantage of currency fluctuations.

How do these contracts work? Spot contracts convert the buyer’s currency at current rates for settlement within two business days. This simple method allows the exporter to take immediate advantage of favorable rates, but provides no hedge against future rate changes. Forward contracts enable the exporter to lock in a rate of exchange for three days to 12 months. And, option contracts offer the exporter the ability to lock in a rate over a desired period without the obligation to buy in the event of favorable market fluctuations.

Protect Yourself and Reap Rewards

Currency fluctuations, regardless of their direction, will impact your business. And no currency is immune from some level of volatility, including the greenback. Consequently, it is essential to identify the risks, take measures to limit the downside, and reap the rewards of favorable exchange rate movements.

To learn more about currency fluctuations and how best to protect yourself, contact your banker.

This article appeared in Impact Analysis, July-August 2003.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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