Recently, the value of the U.S. dollar has risen from strength to strength against a basket of currencies, notably against the euro and the yen. In fact, the dollar has reveled in the longest streak of gains since 1971.
While the strong U.S. dollar is good news for American consumers who can get more bang for their bucks when buying some imported goods or traveling abroad to certain areas, like Europe or Japan, American multinational companies find themselves in a different boat, say experts from Wharton and elsewhere. For one thing, their overseas earnings are worth a lot less when they translate unhedged profits into U.S. dollars.
This can have a big impact on U.S. firms when, for example, nearly 40% of total sales of S&P companies come from abroad. In the long run, however, the higher dollar is a mixed bag of pros and cons for U.S. global companies.
Why the U.S. Dollar Shot Up
How exactly the strong American currency will play out is hard to predict. In just the past year, the dollar has climbed an average of 18% and is now higher than it’s been in more than a decade against major currencies. “People are freaking out about the strong U.S. dollar but in fact it’s been much stronger before,” says Jeremy Cook, chief economist at World First, a currency house in London. “In 1985, it was 33% stronger than where it is now so there is a lot more room to rally.”
“The reason the U.S. dollar is strong is not so much what the Americans are doing but rather what the Europeans are doing with quantitative easing,” adds Mauro Guillén, Wharton management professor and director of The Lauder Institute. As the European Central Bank’s bond-buying program takes off in Europe, the dollar should continue to gain in value over the euro. The dollar is already worth over 30% more than last year against the euro, making Parisian vacations a lot more affordable. Trip Advisor reported a 9% drop in European hotel prices in dollar terms. “Industries that have to do with tourism will benefit, including companies that take American tourists abroad,” says Guillén.
“Companies were caught out a little bit, but what has been bad for American companies has been good for European companies.”— Joao F. Gomes
Undoubtedly, the news is better for European companies than American ones as the former are now able to price products more competitively against American goods. It is already had a huge impact on growth in the eurozone, notes Joao F. Gomes, Wharton finance professor. U.S. importers of foreign-made goods like French wines and German appliances might “experience a windfall” as their products become cheaper, adds Guillén.
The Japanese yen, meanwhile, has slid by 40% since early 2012 in part due to extreme quantitative easing, part of Abenomics, Prime Minister Shinzo Abe’s monetary and fiscal stimulation efforts to escape decades of slow economic growth and deflation. This has put pressure on China — which is experiencing its slowest growth in 24 years — to defend itself in Asia’s currency wars. “There is speculation that the People’s Bank of China will increase policy stimulus this year in the face of slowing growth,” which in turn will weaken the yuan, says Jane Foley, senior currency strategist at Rabobank International in London.
“China and Japan have been involved in a currency war in a very limited way,” adds Adam Slater, senior economist at Oxford Economics. “If they’re doing anything, they’re nibbling away, but they’re not aggressive at this point.” Nevertheless, adding weight to the view that China will force a devaluation was the recent announcement that March exports had fallen 15% from the same period in 2014.
Falling oil prices, set in dollars, also support U.S. dollar gains. A net oil importer, the United States has been reducing its reliance on foreign oil due to shale gas production. America imported 60% of its oil needs in 2005 but by 2015, it will import just 21% of its petroleum products. So, less spending on overseas oil means a smaller supply of dollars circulating there.
What’s more, when it’s cheaper to run your car, Americans get more money in their pockets to spend on other things — including imports. That’s significant when 68% of the American GDP comes from consumption, says Guillén. So far, though, the savings in gasoline expenditures have filtered down in a limited way and far less than most analysts had predicted.
While it might look like good times for the American consumer, U.S.-based multinationals are juggling a different set of factors. Many U.S. companies, from soda giant Coca-Cola to luxury jeweler Tiffany’s, rely on generating half or more of their profits from overseas.
“Through much of last year, volatility in the forex market was low,” says Foley. “This raises the risk that many firms were lulled into a false sense of security over the outlook for currency movements and there may be been some firms that found themselves inadequately hedged this year.”
Adds Gomes: “Companies were caught out a little bit, but what has been bad for American companies has been good for European companies. Things have looked phenomenal for German companies and we’ll see more of that this year.”
How U.S. companies are affected by the high dollar drag and what they’re doing about it varies by company and industry.
“The companies that will be hurt the most [by the strong dollar] will be the ones who produce in the U.S. and export outside the U.S.” –Mauro F. Guillen
“The companies that will be hurt the most will be the ones who produce in the U.S. and export outside the U.S.,” says Guillén. Some companies have global operations, thus currency movements won’t affect them that much, notes Bulent Gultekin, Wharton finance professor. Those firms will use local input for the local markets. If the companies bring the profits back to the U.S., it’s true that their reported earnings will be lower. But corporations should be looking at the long-term growth opportunities and the change in currency will not make a difference in the long run, Gultekin adds.
Guillén notes that for the companies that produce abroad and sell abroad, there might not be an immediate impact because those firms could keep their profits in the foreign currencies and reinvest in foreign operations. Their dollar revenues might look like they’re taking a hit when the companies translate profits into U.S. dollars. However, just because the dollar profits will be smaller doesn’t necessarily mean cash flow will diminish, he points out.
“It will be a mixture of what accounting practices they might use,” adds Slater. He agreed that “some may decide to wait before taking a translational loss and reinvest in foreign markets.” Cook agreed: With other currencies “weakening against the U.S. dollar, American companies have incentives to spend money abroad if they can.”
The weaker euro may also draw more merger and acquisition activity (M&A) as well. “European companies may be more susceptible as takeover targets,” adds Foley. “There is evidence that Chinese investors stepped up interest in Europe in 2010 as the euro fell on the back of the eurozone crisis.” The strong U.S. dollar makes “European companies more attractive to U.S. buy-outs, too.”
“Companies should invest where growth is expected to be higher, like parts of Latin America and Southeast Asia.” –Bulent Gultekin
Technology companies offer a further case in point, given that up to 60% of their revenues flow from foreign markets. Apple is an interesting example. Even as it set the record for the biggest quarterly earnings — $18 billion — for any company in history back in January, the tech giant “lost” $2 billion in sales via currency fluctuations. Yet, it should not make that much difference for Apple, says Gomes. There may be fewer dollars reported as profits, but the firm should be making investment decisions based upon growth, Gomes adds.
According to TechCrunch, Apple is thought to have $54 billion in profits sitting offshore that have not been subject to higher U.S. taxes. “A number of U.S. corporations have been stashing their money overseas. If they don’t repatriate back to the States, then they don’t get taxed back in the States,” notes Gultekin. However, those firms run the risk of getting into the hedge fund business unintentionally, where they might take a hit from trying to predict currency movements, he adds.
A month after setting the quarterly earnings record, Apple announced its largest investment in Europe yet — $1.85 billion (1.7 billion euros) to build two state-of-the-art data centers, powered completely by renewable energy, in Ireland and Denmark. Though the European investment is one way to reinvest euro profits, Apple also benefits from favorable corporate tax rates in places like Ireland, says Cook.
Another interesting case: The airline industry, particularly the U.S.-based Boeing versus the Europe-wide Airbus operations. “Commercial aircraft are priced in U.S. dollars. The higher U.S. dollar in principle allows Airbus to give more discounts and win some sales,” says Olivier Chatain, strategy and business policy professor at HEC business school in Paris and senior fellow at Wharton’s Mack Institute for Innovation Management. “However, this depends, at least in the short term, on Airbus’ currency hedging strategy. It is likely that they locked in some exchange-rate contingencies before the fall of the euro.” He also points out that Airbus has a backlog of eight years of production, but there is also less pressure to buy new aircraft “that are consuming less fuel” in the short term.
Another sector where foreign companies are leveraging their cheaper goods is the American steel industry. U.S. steel needs grew by 13% in 2014, while China’s demand is slowing for the first time since the early 1980s, according to UBS Group AG in a Bloomberg article. China also produces half of the world’s steel, causing an excess in production that pushes down prices.
To add to the complications, big steel exporters like Russia and Brazil are also seeing their currencies drop drastically. The result is foreign steel companies are able to muscle into U.S. markets with lower prices. Gultekin adds, “Importers into the U.S. will certainly have an advantage, and most emerging markets have an export steel industry.”
What Companies Should Do
“Companies should invest where growth is expected to be higher, like parts of Latin America and Southeast Asia,” says Gultekin. On a dollars basis, it should not affect corporate business decisions, which should be done under the fundamentals of operating results, he adds.
Guillén points out that U.S. export companies will now have to focus on being more productive, more proactive and more efficient in order to compete. Moreover, Cook advises that companies hedge away from currency risks by setting up contractual terms on currency values in the beginning and let businesses focus on their own viable business models.
Another complicating factor is the Federal Reserve, which has been widely expected to raise interest rates by the end of the year, though if recent soft numbers on the economy continue, the timing of any change could easily stretch out. That would raise financing costs for U.S. corporations and the U.S. government.
Good for the Long Term
Overall, the robust American currency will have a positive effect on the global economy, experts say. What we’re seeing is a “redistribution of income from countries with a low propensity to consume to countries with a high level to consume, and the whole world stands to benefit” says Slater. “We believe it will be good for the global economy in the long run.”
While it looks like the eurozone may ease out of the doldrums and China is slowing from its former astronomical trajectory, U.S.-based firms need the rest of the world to flourish in order to buy its products. “We have to bite the bullet for now,” Gomes adds. “It might hit profits in the short term but in the long term, growth in the overall global markets will be good for American companies.”