Financefinance

Weakened U.S. Dollar:

Implications on U.S. Based Multi-National Corporations

By: Brad Heivly

 

Impact on Business Operations

            The U.S. dollar has been declining against the Euro for many years now. As a result, companies focused with a global approach, especially in Europe, must slightly alter the style of business operations. The operations of business must coincide with the fact that “the lower dollar will make U.S. goods more competitive overseas, thereby increasing exports, and foreign goods will be less competitive in America, reducing imports” (Wyss). Based on theoretical theory, companies should shift more focus attracting oversea customers, particularly the countries using the Euro because of the increases global competitiveness gained. As well, companies should avoid importing supplies from Euro denominated countries or any other country with a strengthening currency against the weakening dollar. (article continued below)

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cartoon courtesy of www.google.com

Reported Financial Results from Operations

            Based upon the potential positive impact that a weaker U.S. dollar has on U.S. based companies by increasing exports, therefore, reported financial results should favor to higher levels of revenue and profit. In addition, expenses may also be higher depending on where the U.S. based company obtains its supplies from. In essence, if the supplier’s currency is denominated in Euros, then the cost to import the supplies will be higher.

Minimizing Potential Negative Impacts on Financial Results

            Minimizing the impact of the weakening dollar to the strengthening Euro can be done by:

Actively buying supplies needed for operations from the most financially beneficial suppliers (cost-effective suppliers)

Maximizing the level of exports, thus creating more customers

Hedging against fluctuations in the Euro

 

When a higher valued Euro to a weaker dollar exists in the market place, the cost to import will be significantly higher to U.S. based companies. Therefore, companies will want to avoid purchasing supplies from Euro denominated countries to avoid the higher cost. Hedging against the Euro will minimize the impact on financial results by protecting a company from the risk of currency variation during transactions. Hedging against the Euro will be discussed in further detail in the next section.

Foreign Exchange Variability

Foreign exchange variability is an area of key importance for any company conducting multi-national business because of the difference in currency value. “When a firm sells to foreign customers, either the firm or its buyers are subject to the exchange rate risk inherent in such transactions” (Smith). Below is a hypothetical example of the potential impact of this exchange rate variability.

            Suppose 100 units are involved in a transaction at the beginning and end of the year:

Beginning of the Year: $1.10 (U.S.) =  €1 (Euro)

Units Cost: $110 U.S. vs. €100 (Euro)

(Price for a comparable unit from each company’s local currency denomination)

End of the Year: $1.45 U.S. = €1 (Euro)

(Result of Strengthening Euro vs. Weakening Dollar)

Units Cost: $145 U.S. = €100 (Euro)

In reference to the above hypothetical example: In the beginning, Euro denominated countries could only buy $1.10US valued goods for every €1 (Euro), but now as the currencies fluctuate, Euro denominated countries can buy $1.45US valued goods for every €1 (Euro). In essence, Euro denominated countries can purchase more for their money in U.S. But on the negative aspect, with a stronger valued Euro, U.S, based companies must pay more for Euro denominated goods. Overall, the result of this exchange rate fluctuation causes U.S. based companies conducting business in Europe to be more competitive in the global market by increasing U.S. exports (Smith).

 

Conclusion

“A STRONG currency may be a central banker's dream, but it can be a nightmare for companies,” European countries that is (Boschat).

The strengthening of the Euro against the U.S. dollar reluctantly provides U.S. businesses prosperity with increased sales through increased exports.

Investors may start to lose faith in the U.S. because of creditability (Charlton).

U.S. based companies need to exert as much effort as possible into finding European customers to increase exports.

U.S. based companies receiving supplies outside the U.S. need to be prudent purchases and shop for the good deals.

Avoiding Euro denominated countries will be in the best interest of the companies.

If avoiding these types of suppliers is not possible, companies should invest in hedging against fluctuations in the Euro to factor out currency exchange risk.

To maximize revenues and minimize expenses, companies need to devise a plan to that will best fit their operations of how frequently they conduct business in foreign currencies. 

 

Articles Used as References:

 

 

Boschat, Nathalie, and Emma Charlton. "BusinessEurope: Something Must Be Done About Euro Level." Wall Street Journal 12 Nov. 2007. 13 Nov. 2007 <http://online.wsj.com/article/BT-CO-20071112-706346.html>.

 

Charlton, Emma. "FOCUS: Euro Strength to Top Agenda At Euro Group Meeting." Wall Street Journal 12 Nov. 2007. 12 Nov. 2007 <http://online.wsj.com/article/BT-CO-20071112-700725.html>.

 

Desai, Mihir A. International Finance. United States of America: John Wiley & Sons, 2007. 85-100.

Finke, Susanne. SAP Foreign Currency Revaluation. Hoboken: John Wiley & Sons, Inc., 2006.

Smith, William R., and John K. Paglia. The Link Between Price and Profit Margin in a Global Market. Pepperdine University. 2005. 9 Nov. 2007 <http://gbr.pepperdine.edu/051/pricing.html>.

Wyss, David. "A Hurting Dollar Pains the World." Business Week 12 Dec. 2004. 3 Nov. 2007<http://www.businessweek.com/bwdaily/dnflash/dec2004/

nf20041213_3050.htm?chan=search>.

How Gas Prices Work

by Ed Grabianowski and Kevin Bonsor

 

See all Using & Processing Fuel articles

 

Gasoline is the bloodline that keeps America moving -- and tracking gas prices can feel like a roller coaster ride. They're down a little one month, up the next, and then they shoot up more than 50 percent in a year. Plus, they're different depending on where you look. Other countries -- and even other states and cities -- can have very different gas prices from your local Gas-N-Go. To the average person, it probably seems as though there's little rhyme or reason to how gas prices are determined. In this article, we will look at the forces that impact the price of gas at the pump, and we'll find out where your gas money actually goes.

Americans have an insatiable thirst for gasoline. Just look at the amount of traffic on roads and highways, and you'll see that a severe gas shortage would practically cripple the United States. Americans drive ­nearly 3 trillion miles per year, according to the Motor and Equipment Manufacturer's Association (MEMA). That's about 820 trips from the sun to Pluto and back.

 

Average U.S. Gasoline Prices

Year

Price Per Gallon

1980

$1.22

1985

$1.96

1990

$1.22

1995

$1.21

2000

$1.56

2001

$1.53

2002

$1.44

2003

$1.64

2004

$1.92

2005

$2.34

2006

$2.63

2007

$2.85

2008 (to March)

$3.16

Source: U.S. Bureau of Labor Statistics Consumer Price Index (CPI). Average Price Data, Gasoline All Types.

 

The United States consumes about 20 million barrels of oil products per day (bbl/d), according to the Department of Energy. Of that, almost half is used for motor gasoline. The rest is used for distillate fuel oil, jet fuel, residual fuel and other oils. Each barrel of oil contains 42 gallons (159 L), which yields 19 to 20 gallons (75 L) of gasoline. So, in the United States, something like 178 million gallons of gasoline is consumed every day.

 

Typically, the demand for gas spikes during the summer, when lots of people go on vacation. Holidays like Memorial Day and the Fourth of July create logjams of tourist traffic during the summer. This high demand usually translates into higher gasoline prices. Cleaner-burning summer-grade fuels, which are more expensive to produce, can increase the price as well, but prices don't always go up in summer. For instance, while gas prices soared 31 cents in April and early May of 2001, reaching $1.71 per gallon (which seems inexpensive compared to today's prices), prices actually declined during the 2001 summer.

In 2004, prices continued to rise past the end of the summer travel season for a variety of reasons, including several hurricanes and an increase in the price of crude oil. And in 2005, Hurricane Katrina (along with a sizable increase in crude oil prices) pushed prices to $3.07 per gallon on September 5. Prices settled down somewhat in November and December of 2005. But now the numbers are climbing again, with an average price for regular unleaded gas at $3.60 right now (April 30, 2008), an all-time high.

Price increases generally occur when the world crude-oil market tightens and lowers inventories. We will discuss who controls the crude-oil market later. Also, growing demand can sometimes outpace refinery capacity. In the spring, refineries perform maintenance, which can place a pinch on the gasoline market. By the end of May, refineries are usually back to full capacity.

In the next section, we'll look at where the money goes when you pay for gas.

Should We Worry About the Plunging Dollar?
by Jeremy Siegel, Ph.D.


doll

Posted on Friday, May 2, 2008, 12:00AM

The headlines are just plain depressing. The dollar falls to a record low of $1.60 per euro, nearly half its value six years ago, and sinks below 100 Japanese yen. Even the lowly Canadian dollar recently traded above its southern counterpart for the first time in over three decades.

Many blame the recent surge in commodity prices and other assorted ills on the plunging dollar. Despite this, the official position of the Bush administration, as voiced through Treasury Secretary Henry Paulson, is that the government favors a “Strong Dollar Policy.”

Yet policymakers seem to do nothing to keep the dollar strong. And the recent policy statement by the Federal Reserve, although hinting that there may be no further rate cuts, may not be enough to keep the dollar from plunging further.

What is the real story of how the dollar impacts our economy and should the government take steps to support our currency?

Some Exchange Rate Basics

Ever since the breakup of the fixed exchange rate system in the early 1970s, exchange rates of the major currencies in the world have been largely determined by supply and demand in free foreign exchange markets. The demand for dollars is determined by foreign demand for US exports and US capital, while the supply is determined by our demand for foreign goods and foreign capital. The dollar has fallen over the past year for many reasons; but most important are the Fed’s reduction of interest rates, the slowdown in the US economy, and the surge in US petroleum imports, which increases the supply of dollars on the currency markets.

The falling dollar worsens inflation by increasing the prices of imported goods. Over the past year, crude oil has nearly doubled to almost $120 per barrel, a much larger increase than oil’s price in euros or yen. Furthermore, the prices of imported goods from salmon to copper to cocoa have increased sharply as the dollar sank.

The falling dollar is not all bad. It has been a major factor in increasing US exports at a 10% annual rate over the past several years. And, despite disappointing trade data for February, our trade deficit appears to have peaked at $67 billion in August 2006 and has since been trending lower.

Furthermore there is no question that the profits from non-US sales are among the bright spots in first quarter’s US corporate earnings reports as those firms with large international exposure have far outpaced those that rely on slumping US demand. If you are in the export business, there is no question that the falling dollar brings a smile to your face.

But in general the benefits of a falling dollar do not outweigh the negatives. We are all consumers who suffer from higher imported prices while the gains from a weaker dollar are concentrated in a much smaller group of exporters and internationally-oriented firms. Even stockholders might not gain as rising inflation raises interest rates and raises the effective tax on capital gains which are not adjusted for the inflation.

Policies to Support the Dollar

If a falling dollar hurts more than it helps, why doesn’t the government pursue policies to strengthen the dollar? The simple answer is that to do so would require a reversal of the Fed’s easy money policy designed to combat the financial crisis. Although the Treasury Department has formal jurisdiction over the dollar exchange rate, in today’s capital markets the Treasury can do very little to change the dollar’s direction without help from the Fed.

The reason is that markets have changed. Long gone are the days when governments could buy a few billion dollars of their currency in the foreign exchange market to raise exchange rates. In today’s global markets, hundreds of billions of the dollars would be needed to effectively boost the greenback. The only way to attract that capital would be to raise the reward from holding the dollar – specifically boosting short term interest rates, which is under control of the central bank, not the treasury. Given the current weakness of the US economy, raising rates would be a tough choice for the Fed.

I have always been a fan of market-determined exchange rates, free of government interference. The collapse of the dollar is a symptom rather than a cause of our current problems. In order to help our economy pull out of the credit crisis, the Fed has vigorously pursued an easy monetary policy by lowering short-term interest rates and increasing the supply of credit. This policy has stabilized the financial system, but it has also fed the current commodity price surge and decline of the dollar.

All told, we do need to worry about the plunging dollar. We are now at the point where the Fed has done enough to stimulate the economy by lowering interest rates and must turn its attention to the inflationary implications of the sinking dollar. I hope that the recent hints that Fed is done easing are enough to strengthen the dollar. But if they are not, the Fed must reverse direction and raise interest rates. Ultimately price stability will benefit our economy far more important than the short-term stimulus of another rate cut.