Friday, June 21, 2013

The Dollar is Appreciating in value in the FOREX. That HAS to be good, right? Well, yes and no. Let me explain...

In an era of globalization, the value of one currency relative to another is no small thing.  Any changes in relative values can have significant effects on an economy.  This short article discusses the ramifications of an Appreciation of the US dollar in the Foreign Exchange Market on US exports---stuff we make and sell to foreigners.

Are U.S. exports about to get hammered by the rising dollar?

After Fed chairman Ben Bernanke’s press conference on Wednesday, the dollar started climbing against major developed nation currencies as well – rising nearly a percent against the euro and the British pound, and around 1.5 percent against the Japanese yen. The dollar index, measuring its value against six other major currencies, rose 1 percent Wednesday and was up another 0.5 percent Thursday.
If that global trend continues, it makes U.S. products – from soybeans to trucks and airplanes – more expensive overseas at a time when the Obama administration is banking on international sales of American goods to generate jobs.
Simple example. I sell widgets to Europeans at a price of $100.00.  Assume the exchange rate is 1 Euro = 1 Dollar (reciprocal is true 1 Dollar = 1 Euro).  So a European exchanges 100 Euros for 100 Dollars and buys my widget.

Assume the exchange rate changes such that 1 Euro = 80 US Cents (the reciprocal would be 1 Dollar = 1.25 Euros ). This means for Europeans to get enough US Dollars to buy my Widget they would need to exchange 125 Euros ($100 Dollars/the exchange rate of 80 US Cents = 125).  That makes my widgets 25% more expensive for Europeans. I am likely to sell much less to them!!

Hold on. The article suggests this might not be quite that bad.
Exchange rates don’t have a one-to-one effect on the prices of final goods. Global companies use different strategies to protect against currency swings, and many firms rely on imported parts and other inputs – which get cheaper when the dollar is stronger, offsetting the impact of a rise in the value of the currency.
If I happen to use a significant amount of European sourced INPUTS in my making my final OUTPUT of widgets, the outcome will be a little different.

Assume half of the cost of producing my widgets (50 Dollars) comes from materials I buy from Germany (imports to the US).  Before the currency change I exchanged 50 Dollars for 50 Euros.  AFTER the currency rate change I only have to exchange 40 Dollars to get 50 Euros (50 Euros/the exchange rate of 1.25 Euros = 40). So now my costs have decreased 10 Dollars.

If I am in a competitive market, then my price for widgets will decrease from 100 Dollars to 90 Dollars.  At that price, Europeans will need to exchange 112.50 Euros to buy my widget (90 Dollars/80 Cents= 112.50).

Better than the 125 Euros we calculated before but more importantly it accurately reflects what happens with trade when currencies change in value relative to each other.

If a US business relies heavily on domestic sourced inputs then the effect of an appreciating currency is greater and can have a larger impact on exports.  The Quantity Demanded for US goods/services will decrease.

The more a US business relies on imports for a significant amount of its inputs, then an appreciation of the dollar can have a less adverse effect on exports.  The Quantity Demand for US goods/services will decrease, but by a lesser amount.

The Law of Demand is hard to defeat.

As with most things, the deeper you dig the less clear and complex they become.

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