Scenario Planning - the U.S. Dollar implications

Most Americans pay no attention at all to the value of the U.S. dollar.  As an island nation, and largely an importer of goods, all most Americans care about is how much something costs at the store.  Since the vast majority of Americans never set foot on foreign soil in any year, they just don't think about how many Euros or Yen you get for a dollar.

But they should.  We now live in a global economy.  People in foreign countries have a direct impact on the lives of Americans every day.  And they watch the value of the dollar constantly.  Just look at outsourcing - the transfer of jobs offshore.  Or the cost of products at Wal-Mart - mostly made in foreign countries (China) in foreign currency values.  All scenarios of the future, all planning, has to include scenarios for the value of America's currency.  And that is true for all companies, in all countries, because the U.S. dollar is the primary basis for pricing everything in the world.

There's a great chart showing the U.S. dollar value at FXStreet.com.  This shows that in 2001 the dollar compared to other currencies was at a value of 120.  Since then the value has plummeted to about 75 (there was a rally earlier in 2009, but almost all of that has been given up.)  This means if you went to Paris on holiday in 2001 you could buy a Euro for $.75.  So taking your own personal "National Lampoon's European Vacation" was affordable.  Now, a Euro costs you almost $1.50.  So, it costs twice as much.  With all that value loss happening prior to 2009 (during the previous administration and the previous stock market highs.)

So you don't plan to go to Europe on vacation, you say.  That's a good thing, because you probably can't afford it.  But, as American homes go into foreclosure, who do you suppose is buying them?  To foreigners, American houses are extremely cheap.  In coastal areas of Florida, as many as half of all home sales are to foreigners - and upwards of 90% of those are cash transactions - no loan!  While Americans struggle with mortgages, others are buying American houses as vacation spots. 

One way to think about this is how many ounces of gold does it take to buy a house?  Gold is a store of value, like a house.  Its limited supply and abundant uses to allow it to remain a good measure of value.  InvestmentTools.com has a great chart showing the value of U.S. houses. in 1985, as America was crauling out of the horrible 1982 recession it took about 280 ounces.  In 2000, the value peaked at about 780 ounces - so by global standards, American houses had tripled in value.  But today, the value has declined again to 280!  So globally, we're no more wealthy now than we were at the worst recession since the Great Depression - and value is falling as we're still in a major recession.

If Americans have trouble paying their child's college fund, that's not the problem for students from offshore.  Many are so relatively wealthy they now can buy condo's for $200,000 or $300,000 to live in while attending schools.  They relative wealth of their offshore parents means that there are dramatically more offshore students who find an American education affordable - while Americans are finding education increasingly unaffordable for their own citizens.

To someone from outside America, the country is on sale!  Because everything in America costs half - or often far less than half because America has no excise or Value Added Taxes.  So people from Europe, Asia and the middle east fly to New York to go shopping - and save enough to pay for the plane ticket!  Some even fly to America to buy goods from their own country because the products are cheaper priced in dollars and without the taxes!

And actually, America is acting just like a business facing foreclosure.  Debts have been mounting.  Each year, America sells more assets in order to pay interest on the debt.  In this bad economy, as income has declined, even more asset sales happen.  States are selling highways to foreigners in order to get cash today in exchange for road tolls the next 100 years.  Or in Chicago - the sale of all the parking meters.  Those in other countries are buying fire-sale assets to give Americans the money just to pay the interest. 

Meanwhile, the debt keeps rising.  Each month sales of bonds exceeds redemptions.  For those buying the bonds offshore, this is pretty amazing.  If a bond yields 3% (or say even 5% of 6%) that value has been overwhelming wiped out by the decline in the principle value.  Remember, the dollar value of those bonds has dropped by 50% just in this decade!  There's no way to recover that through interest collection.

So why do these offshore folks buy the American bonds?  It's kind of like townspeople buying bonds to prop up a local business.  If the local plant goes bust, then the jobs go away.   Then the restaurant has to close shop.  Then the bank has to close because the plant can't repay its loan.  So the people keep buying plant bonds to keep it open - to forestall an imminent disaster.  And because they hope that the plant will someday start making enough money to repay the bonds.  That it will someday see employment rise, not fall.  And the restaurateur, and the machine shop owner, and the car dealer all keep buying bonds to keep the plant going.  The American central bank calls those folks who buy U.S. bonds the central banks of China and other countries.

How low will the dollar go?  If people quit buying bonds, really low.  Increasingly, those who produce commodities like oil and gas are asking to price commodities in something other than dollars.  They don't like seeing their prices halved due to currency devaluation.  If businesses don't have to trade in dollars, then they don't need the dollar value to remain high - and they lose interest in buying bonds to prop it up.  

American's don't pay attention to other currencies either.  So most don't remember the 1994 Mexican Peso crisis.  Mexico had incurred a huge debt, and was selling more debt from the 1970s into the 1990s.  The primary source of revenue had been oil and gas sales, but prices collapsed in the 1980s, and production failed to keep up with that from other countries.  There was more spending than revenue collection.  When the Mexican government stopped propping up the Peso, it dropped more than 50% in a week!  Currency devaluations can happen fast, and can be devastating, because suddenly a flood of buyers become sellers - reversing position and cratering the value.  To keep the government and economy from collapsing the U.S. central bank stepped in to buy bonds and stop further devaluation.

This blog is sure to not be one of the more popular.  Because most Americans simply don't care about the dollar's value - and even more don't understand anything about currency values.  Americans are so used to assuming that the dollar will be the world's currency, and that it will be propped up by foreign debt buyers, that they simply expect the future to be like the past.

I'm not predicting the future value of the dollar.  But what's clear is that the dollar's value is really important to the future of your business.  Whether in America, or not.  What kills businesses isn't the things management knows and plan for, it's what they don't plan for.  And most American business planners pay very little attention to the value of the dollar.  But having a robust scenario around the future value of the dollar could prove to be the difference between many winners and losers  in as quick as 12 to 24 months.  There are plans that can leverage these shifts in ways to create enormous value.

Is your company, as it prepares budgets for 2010, prepared to deal with a drmatic shift - up or down - in the value of the U.S. dollar?  Have you considered the impact, and developed contingency plans?  Do you have White Space projects that will leverage currency shifts?  If you're planning from the past, you may well not be prepared for a very different future if the U.S. dollar's value shifts dramatically.  Especially if it continues falling.

Comments

[Larry Becque]

Interesting topic. With all the talk on the news lately about the dollar losing value and some speculating that USD will someday no longer be the standard reserve currency this topic is very relevant. I had found that same chart on fxstreet.com but what is even more shocking is if you change the frequency to monthly and look at the dollar index over the last 9 years, the trend has been downward for some time! 11% down last year but 41% down over the last 9 years!

This trend is not unique to the US. I was in London in 2007 working on a project for quite some time while the pound was fairly stable compared to the USD at 1 GBP = 2 USD. I returned in May of 2009 to find that 1 GBP was only worth 1.5 USD. So GBP had fallen 25% faster than the USD! It has now made a slight recovery but is still down 15% against the USD. In fact though the British pound is about the only major currency that has done worse than the USD, for most other currencies the USD is down almost 20% over the last several years.

Interestingly, there are some that argue that a falling dollar is good for the economy saying that it makes off-shoring more expensive and encourages manufacturing in the USA. This topic often comes up in regard to China and did so today, see:
http://online.wsj.com/article/BT-CO-20091119-712384.html
In Treasury Secretary Geithner's testimony he implies that China is keeping their currency undervalued in order to suck jobs away and the Chinese Yuan has in fact kept pace in falling with the dollar 17% over the last 4 years.

I have to ask myself would a stronger dollar or a weaker dollar fix the US economy? Or is this simply a symptom of a chronically ill US economy? I think the latter. What we need in the USA are better managed companies that lead the world in technology and innovation. If we do that the value of the USD will fix itself. The decline in the USD is a symptom that the USA is falling behind or at least that the rest of the world has caught up.