I would either begin and/or end with this video:
Let’s say you just graduated from a SCM program. You have accepted a job offer from Boeing as an Assistant Buyer. The job takes you to Seattle, Washington. You will help Boeing identify suppliers to help meet its material needs. You must immediately find a supplier which can supply Boeing with electrical wiring harnesses. You find a supplier in Japan by the name of Toshiba. You have selected Toshiba because this company meets all of your cost and performance (e.g., quality, service, flexibility) expectations.
You negotiate a contract to purchase these electrical wiring harnesses from Toshiba, which is based in Japan. You decide that the contract calls for payment to Toshiba in Yen (foreign currency). When the contract is signed, the exchange rate is 132.24 Yen per 1 U.S. Dollar. It just so happens that you agree to pay 132.24 Yen for each electrical wiring harness (how convenient). No exchange rate fluctuation clauses are built into the contract (the price for each electrical wiring harness will always be 132.24 Yen – whether the Dollar strengthens or weakens). The terms and conditions of the contract are eventually completed and payment by Boeing is made at a future date. However, the exchange rate on this future date is now 124.73 Yen per 1 U.S. Dollar.
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As a result of exchange rate fluctuations…
a. Toshiba’s revenues have actually increased for the contract, and Boeing’s costs have also increased.
b. Toshiba’s revenues have actually decreased for the contract, and Boeing is indifferent.
c. Toshiba’s revenues have actually increased for the contract, and Boeing is indifferent.
d. Toshiba is indifferent, and Boeing’s costs have increased.
e. Toshiba is indifferent, and Boeing’s costs have decreased.
Answer: d. Toshiba is going to get the same amount of Yen per part no matter what happens. Toshiba will get 132.24 Yen for every part no matter what. Also, they are a Japanese company so they have their currency and do not need to exchange it for another currency. They are good to go. How about the American buyer (you)?
Day 1 – $1 = 132.24 Yen
Day future/later $1 = 124.73 Yen
Has the dollar weakened or strengthened? Well, in the future, when you go the bank they will only give you 124.73 Yen for $1. Before, they would give you 132.24 Yen per dollar. So, in the future, the same amount of U.S. dollar gets you “less” Yen. That means it has weakened. You have to come up with more U.S. dollars to pay for the same part because you need more U.S. dollars to pay them the 132.24 Yen that you promised.
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In the example above, did you make the right decision by calling for payment to Toshiba in Yen rather than U.S. Dollars? Explain.
Answer: No. You decided to pay a foreign supplier in their currency. That means you have to go to the bank and exchange your U.S. money for yen. During the life of the contract, the dollar became weaker. That means you get less yen back for the same amount of U.S. money. That means you have to come up with more U.S. money to buy the same amount of material. You are costing your company more money. You should have been paying the foreign supplier in dollars. You will not be getting a merit raise this year.
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In the example above, has the U.S. Dollar strengthened or weakened relative to the Yen?
Weakened. Why?
Day 1 – $1 = 132.24 Yen
Day future/later $1 = 124.73 Yen
Well, in the future, when you go the bank they will only give you 124.73 Yen for $1. Before, they would give you 132.24 Yen per dollar. So, in the future, the same amount of U.S. dollar gets you “less” Yen. That means it has weakened. You have to come up with more U.S. dollars to pay for the same part because you need more U.S. dollars to pay them the 132.24 Yen that you promised.
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If the payment to a foreign supplier is in U.S. currency, then the U.S. buyer assumes no risk and gets no reward from exchange rates. True or False.
True
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If payment to a foreign supplier is in foreign currency, then the U.S. buyer is worse off with a strong U.S. Dollar, and better off with a weak U.S. dollar. True or False.
False
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If payment to a foreign supplier is made in U.S. currency, and the dollar weakens, then the U.S. buyer’s costs increase and the foreign supplier is indifferent. True or False.
False
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If payment to a foreign supplier is made in foreign currency, and the dollar strengthens, then the U.S. buyer’s costs decrease and the foreign supplier is indifferent. True or False.
True
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Also,…
The dollar is rising, the dollar is appreciating, the dollar is getting stronger, more foreign currency for the dollar- what does all this mean? It is happening right now in the economy.
If the dollar goes up in value, American goods become more expensive relative to foreign goods, or, foreign goods become cheaper relative to American goods. Therefore, exports fall, and imports rise (make sense? So, what happens to GDP?). This happened during the 1980s (and it is happening again right now). For example, a weaker yen compared to the dollar meant Japanese products were cheaper to buy for Americans.
For example:
2014 – $1 = 100 Yen
2015 – $1 = 200 Yen
First question, can you see that the dollar has gotten stronger since 2014? Why, the bank used to give you 100 Yen when you gave them $1, but in 2015 the bank will give you $200 Yen for the same $1. Your dollar is worth “more”. It has strengthened.
Also, again,
2014 – $1 = 100 Yen
2015 – $1 = 200 Yen
Let’s say a Japanese company sells a truck in America to an American for $1. The Japanese company goes to the bank with $1 and the bank gives them 100 Yen because that is what the exchange rate is in 2014. With 100 Yen the Japanese company is happy because they paid their bills and have some money left over. Let’s move forward to 2015. What could the Japanese company sell the truck for and still get their 100 Yen? This is VERY important to understand. The dollar has gotten stronger, so when the Japanese company goes to the bank with the dollar, the bank will give them more Yen (200 Yen now in this example). So, again, in 2015, what could you sell the truck for and still get 100 Yen? Answer: in this example, you could drop the price to $.50 and still get the 100 Yen. When the dollar gets stronger relative to other currencies, everything and anything that is American gets more expensive. Likewise, when the dollar gets stronger, everything and anything that is non-American gets cheaper. So, when the dollar gets stronger, the non-Americans lower their prices (because they can with a stronger dollar) and we buy more non-American stuff. Do you remember the GDP formula?
GDP = C + G + I + (X-M) or
Consumer spending + government spending + investment spending + exports – imports
So, when the dollar gets stronger relative to other currencies, everything and anything that is American gets more expensive.
So our exports go down because American stuff is more expensive, non-Americans buy less American stuff.
Likewise, when the dollar gets stronger, everything and anything that is non-American gets cheaper.
So imports go up because we buy more non-American stuff.
Did you catch this part?
When the dollar gets stronger relative to other currencies, everything and anything that is American gets more expensive.
So our exports go down because American stuff is more expensive, non-Americans buy less American stuff.
Remember
2014 – $1 = 100 Yen
2015 – $1 = 200 Yen
Let’s say an American company like GM sells a truck in Japan to a Japanese consumer for 100 Yen. The American company goes to the bank with 100 Yen and the bank gives them $1 because that is what the exchange rate is in 2014. With $1 the American GM company is happy because they paid their bills and have some money left over. Let’s move forward to 2015. What does the American GM company have to sell the truck for to still get their $1? This is VERY important to understand. The dollar has gotten stronger (which means the Yen has gotten weaker), so when GM goes to the bank with the 100 Yen, the bank will give them less $ (because the Yen has gotten weaker). In this example, the bank will only give them $.50 for 100 Yen in 2015. So, again, in 2015, what would GM have to sell the truck for in Japan and still get $1? Answer: in this example, you would have to raise the price to 200 Yen to still get the $1 (you have to double the price of the truck). Now the Japanese consumer is saying, no thank you, too expensive. So, American exports go down, GDP goes down, some Americans lose their jobs.
Keep in mind that the Japanese (Yen) and Chinese (Yuan/RMB) governments routinely and intentionally manipulate their currencies to make their currencies weaker relative to the dollar. Why? When the dollar gets stronger relative to other currencies, everything and anything that is American gets more expensive. People in Japan and China buy less American stuff and more of their stuff (imports go down in their countries). Likewise, when the dollar gets stronger, everything and anything that is non-American gets cheaper. So, when the dollar gets stronger, the non-Americans lower their prices in America (because they can with a stronger dollar) and we buy more non-American stuff (because they lower their prices because they can with the stronger dollar). So exports from Japan and China increase (we buy their cheaper stuff). Japan has been trying to export their way out of a recession for several years by trying to make its currency weaker relative to the dollar. It has not really worked. They have been in a very deep recession for a very long time. China pegs it currency against the dollar. Why? If it allowed its currency to float openly on the free market based on supply and demand conditions then it would be 30% stronger relative to the dollar. That means everything and anything that is Chinese would be 30% more expensive. What is China’s cost advantage? Answer, around 30%. That means they lose most of their cost advantage if they play by the same rules. I think it is an unfair trade practice when governments give their companies a cost advantage through currency devaluation because it has nothing to do with better, faster, cheaper. Let the best company win based on fair competition. Around half of America’s trade deficit is with two countries (China and Japan). However, our trade deficit as a % of our GDP puts a small dent in it (because we still export a ton, but we do import more than we export, that has been the case every year since 1976).
OK, how about the reverse? This happened in general during 1991-2009…
The dollar is declining, the dollar is depreciating, the dollar is getting weaker, less foreign currency for the dollar – what does this mean?
American goods are becoming cheaper relative to foreign goods. This is what happened during the 1990s and all the way up to 2015ish.
How do these changes impact the GDP (focus on the exports/imports part of the GDP formula)? The U.S. dollar has been weakening in value relative to the Euro over the last several years (until rather recently)? How does this impact the U.S. and Euro-Zone economies respectively? The Japanese government has been manipulating the Yen to try and weaken it relative to the U.S. dollar. What is Japan trying to do? When Japan weakens its Yen relative to the dollar, then everything and everything that is Japanese becomes cheaper. So, Americans buy more Japanese stuff because it is cheaper. Japan has been trying to export its way out of a recession for almost 20 years now by manipulating its currency.
Again – The Chinese government has pegged their currency (Yuan/RMB) to the dollar. If China did not do this, its currency would be 30% stronger relative to the dollar (what would this mean to China’s labor cost advantage? – Hint: anything and everything Chinese would be 30% more expensive). What is China trying to do (Answer: Protect its huge export market, especially to the U.S., is this free/fair trade?)? Ask a low skilled American manual laborer how this has worked out for them. Welcome to the global economy (good or bad, right or wrong).
What makes up GDP?
Do not forget this…
Consumer expenditures (C) + Government Spending (G) + Investment Spending (I) + (Exports (X) – Imports (M))
Red alert, the U.S. dollar is roaring back and getting stronger again…
https://money.cnn.com/2018/05/02/investing/strong-dollar/index.html
| Trump: The dollar will ‘get stronger and stronger’money.cnn.comJust a few weeks ago, the dollar was falling and companies were celebrating the benefit to earnings. Will a rebound for the greenback be a problem for Wall Street? |
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Large U.S.-based corporations often set the terms and conditions of a contract when doing business with a smaller foreign supplier. Based upon my experiences, large industrial customers which use foreign suppliers will choose to pay the foreign supplier in their currency if they think the U.S. dollar will strengthen during the life of the contract. The U.S. buyer’s costs decrease in this situation, and the foreign supplier is indifferent. However, if the U.S. dollar weakens, the U.S. buyer’s costs actually increase. Large U.S. industrial customers like to take chances because they can afford to.
While I was with Delco Electronics (now a part of Delphi), we made all of our own circuit boards. The circuit boards went into radios and engine control modules (the brain for the engine). However, we did not have the capacity to meet all of our circuit board needs. One option was to add the required capacity by expanding our facilities in Kokomo, IN. The other option was to outsource our extra circuit board needs to another company. We chose the latter option since expanding our facilities would have resulted in idle capacity during an industry slow down. Delphi was predicting an industry slow down in the near future and did not want to add capacity which would sit idle. Delphi could not find any suppliers in the U.S. which could adhere to a strict quality-controlled production environment (the circuit boards had to be built in a dust free environment). However, we did find a supplier located in Japan which could meet our quality requirements.
Delphi established a contract with the Japanese supplier and both sides agreed that payment would be paid in the foreign supplier’s currency (i.e., Yen). During the life of the contract, the U.S. dollar became weaker relative to the Yen. This meant that Delphi’s costs increased during the course of the contract. Delphi thought that the dollar would strengthen relative to the Yen (like it did during most of the 1980s, and it is happening again right now). Delphi guessed wrong and it cost them dearly. Furthermore, the auto industry flourished in subsequent years. Sales and the need for circuit boards actually increased during a time when Delphi thought they would decline. It would have been cheaper for them to expand their facilities and build the extra circuit boards themselves (rather than outsource them to a foreign supplier).
Delphi should have paid the foreign supplier in U.S. currency. The U.S. buyer assumes no risk from exchange rates in this situation; however, the U.S. buyer also gets no reward from exchange rates. Small companies typically pay foreign suppliers in U.S. currency because they cannot afford to take any risks. Delphi has since hired an economist to help them predict what will happen to exchange rates. Delphi has become one of many companies in the U.S. which is outsourcing more and more of its material needs to foreign sources of supply.
Now, smaller U.S. companies typically pay non-domestic suppliers in U.S. currency because they cannot afford to take these types of risks. The long-term win-win solution for companies of all sizes is to reduce risk for both sides. This can be done by having caps and bottoms on what will be paid based on exchange rate fluctuations. In other words, you have escalation clauses built into the price so as to share in the risk and rewards. Smaller companies can negotiate these types of contracts not only with their non-domestic suppliers (after all, you are the customer regardless of size), but also their non-domestic customers that might have a preference for making payment in their own currency.
Exchanges rates are determined by the long-term supply and demand conditions of one currency relative to another. These conditions are influenced by almost everything on a continuous basis (e.g., interest rates, exports, imports, taxes, consumer spending, etc.). It is therefore very difficult to make predictions regarding exchange rate fluctuations. Hedgers try to do this in the currency market, but they seem to lose as much as they make. Save yourself the risk and do not be a hedger. Build clauses into your contracts that allow both sides to share in the risks and rewards.
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OK, after all that you should be able to read this and understand it…
http://www.mlive.com/sponsor-content-n/?prx_t=JagCAHuQOAKsILA
What a Stronger Dollar Means for U.S. Stocks
A Strengthening Dollar May Boost Non-U.S. Companies
By: George R. Evans, CFA, Chief Investment Officer, Equities, Portfolio Manager
One can imagine President Donald Trump at least thought about tweeting that the night before the U.S. Federal Reserve raised its benchmark interest rate by 0.25%.
Frankly, we were somewhat surprised at Trump’s silence on this matter given his frequent criticisms of Fed Chair Janet Yellen over the last year. But tweets or no tweets, the bond market’s reaction to the third interest rate hike in 10 years shows that the market has already discounted the likelihood of further interest rate hikes for the rest of the year.
But in the meantime, the outlook for continued strength in the U.S. dollar has many investors questioning what that will mean for their foreign equity assets.
This is a fair question, and one that is worth taking some time to think through.
For U.S. dollar investors, a strengthening dollar does have the immediate effect of reducing the dollar price of non-dollar securities — including equity securities. But an equity security is more than a piece of paper. It represents a share of ownership in a company and a stake in that company’s present and future earnings. But how will a rising dollar impact those earnings?
For companies that sell goods and/or services in the United States but are headquartered overseas, the initial earnings effect is positive. Strong dollar revenues are translated into weaker domicile currencies. This results in higher domicile currency earnings than would otherwise be the case. In a nutshell, as the dollar rises, so do reported earnings. But that’s just accounting.
How a Strong Dollar Impacts a Non-U.S. Company’s Operating Costs
What’s even more interesting is the effect that currency rates can have on a company’s competitiveness. A company that pays its operating costs in a weaker currency than that of its competitors is in an advantaged position. It enjoys lower operating costs than competitors, which will widen margins and result in higher profits.
It also has additional pricing flexibility. Thanks to a weaker operating currency, this company has the option of lowering prices without suffering from narrower margins. Rather than taking on higher margins, it can decide to keep stable margins while trying to increase market share. Or the company may take the opportunity to look further into the future and use its increased financial flexibility to improve its market position and widen its defensive moat.
Examples — depending on the industry — could range from expanding an after-sales service network to increasing research and product development efforts.
The point here is that a stronger dollar, should it persist, will have an effect on companies around the world. For companies that are domiciled overseas — particularly those that compete with U.S. companies — that effect is potentially quite positive in terms of profitability and competitiveness.
More help if you need it…
Thank you. Sime