A strong dollar is a sign of confidence by international investors in that currency. But it's also a killer for U.S. exports. American products are less competitive abroad when buyers have to pay in dollars. (At the same time, of course, U.S. imports become cheaper, which benefits the consumer. So goes the perpetual seesaw of global trade.)
Over the last year, following a period of relative stability, the dollar has been strengthening steadily against a basket of currencies, including the euro, British pound, Canadian dollar, Indian rupee and to a lesser extent the Chinese yuan. The woes of the euro are especially evident, triggered by uncertainty over the fate of the eurozone and the status of troubled economies such as those of Greece and Spain. Given the political bent of Greece’s new government, it’s difficult to see how that country can resolve its debt problems with the International Monetary Fund and the less encumbered members of the European Union. The nuclear option – Greece’s withdrawal from the eurozone – could have a devastating effort on its own economy, as well as those of its neighbors.
Under such a scenario, the U.S. dollar could be the last currency standing. But even if that outcome doesn’t play out, traders need to be acutely aware of potential currency swings, and incorporate them into their global risk analyses.
They might have been lulled into complacency by the period between 2009 and 2014, a time of “unusual stability” in the value of the dollar, says Jeff Parker, chief operating officer of USForex, a foreign-exchange service. Exporters began seeing a return to historic norms toward the end of last year. Expectations that the Federal Reserve Bank would finally raise interest rates were among the factors. Ironically, though, it was good news – specifically, recovery in the U.S. – that drove much of the upward swing of the dollar. Moreover, when other countries begin to experience economic uncertainty, as we’ve seen in the EU, the dollar becomes a safe haven for investors.
The rising value of the dollar hasn’t assumed crisis proportions – especially when compared to the Swiss franc, which is so strong today that the Swiss National Bank has attempted to assess negative interest rates on holders of the currency. (For the most part, they’re hoarding francs as a reaction to the cratering Russian ruble.) But a strong dollar remains a big concern for American companies large and small. Even U.S-based multinationals doing business in multiple currencies must eventually convert their revenues back to dollars – and they’ll get hit hard when they do.
China remains a wild card in the poker game of international currency exchange. The country has come under attack from U.S. lawmakers for keeping its currency weak, thereby making its own exports more competitive in world markets. But Park says the yuan has been slowly appreciating in recent months, and has remained relatively stable against the dollar. In the face of slower economic growth, and fearing the brutal effects of deflation, China has been undertaking an easing of its monetary policy. In theory, that should lead to a stronger yuan, benefiting U.S. exporters, but don’t expect it to happen overnight.
In the face of these developments, many of which were impossible to foresee with any accuracy, what should global companies have done? And what should they be doing now? The answer, says Parker, lies in the adoption of policies that will mitigate if not eliminate currency risk.
Traders might consider the same policy that has helped to smooth out the uncertainties of oil supply and demand: hedging. At a time when prices were on the rise, some transportation providers made forward buys of fuel, locking in their rate for several years. Southwest Airlines was among those to take full advantage of the strategy, which kept it profitable at a time when many rivals were bleeding red ink. (Today’s relatively low oil prices, of course, make hedging less of an attractive option – at least for now.)
Currency can be hedged as well. USForex advises its U.S. clients to lock in an exchange rate for all or a portion of their cash-flow-based activities, including production and import costs. If they believe the currency is going to move in their favor, they might reduce the hedge to half that amount. Option contracts are also available to help limit the downside from a stubbornly strong dollar.
While that seems like a reasonable move to make, many international companies have failed to consider it. Nor have they attempted to dabble in other currencies. Parker blames “a general lack of understanding in terms of the products and how they work.” U.S. businesses, he says, have become accustomed to trading in U.S. dollars. But as globalization continues to expand, international currency markets will open up, spurring increased trade in foreign currencies.
Which doesn’t necessarily mean that arbitrageurs should start stocking up on rupees or yuan. In the near term, Parker believes, the dollar will remain strong. Longer term, there are opportunities to participate in the currency markets of emerging economics such as China and India. Companies might at least begin thinking about embracing true globalization on the financial side.
In the meantime, they should act to protect themselves against the impact of a strong dollar, which will only get stronger if the Fed finally pulls the trigger and raises interest rates later this year. It’s just one more element of a well-considered strategy for supply-chain risk management, which should be front and center of every executive’s global strategy today.