currency project

Currency Project

By Jason DaeSun Park October 13, 2009

Managing in a Global Economy Professor Movassaghi

Table of Content

Introduction... pg. 1

Analysis of the Exchange Rates... pg. 1-2

Economic Factors affecting the US Dollar... pg. 2-7

The Response of Japanese & European Companies... pg. 7-9

Conclusion... pg. 9

Appendix... pg. 10-13

Work Cited... pg. 14-15

Purpose & Significance The purpose of the currency project is to evaluate the exchange rates between the US Dollar,

Euro and the British Pound, to analyze the causes and consequences of any significant changes within

the past two years and to examine the changes made by companies around the world due these

changes.

Analysis of the exchange rates (USD, EUR, & JPY) Comparing the US Dollar to the European Euro since it was first introduced in 2002, the US

Dollar had depreciated between 2007 and 2008. However, in the middle of 2008, the USD rose in value

until the beginning of 2009 where the USD started depreciating again. The current trend of the USD

since the beginning of this year has been negative. (Please refer to Exhibit A) I also looked at the US

Dollar Index which measures the performance of the US Dollar against a variety of currencies including

the EUR, JPY, GBP, CAD, CHF, and SEK. (Please refer to Exhibit B) The trend appears to be relatively the

same when comparing the Dollar to the Euro as the Dollar Index has depreciated since the beginning of

2007 until now. Looking at the Euro Index, it seems to have an inverse relationship to the Dollar Index.

The Euro Index measures the performance of the Euro against major currencies. (USD, GBP, JPY, CHF,

and SEK) The Euro Index has increased relative to the other currencies since the beginning of 2007.

(Please refer to Exhibit C)

Comparing the US Dollar to the British Pound, the USD stayed relatively neutral since 2007.

However, in the middle of 2008, the USD has appreciated against the GBP until the beginning of 2009.

From then on, the USD depreciates again. (Please refer to Exhibit D) The British Pound Index measures

the performance of the British Pound against a combination of other currencies. (USD, EUR, JPY, CHF,

and SEK) By examining the British Pound Index, there is a clear inverse relationship relative to the US

Dollar and British Pound. (Please refer to Exhibit E)

Since 2007, there has been a downward trend showing the depreciation of the USD against the

Japanese Yen. (Please refer to Exhibit F) By analyzing the Japanese Yen Index, it shows that the Yen has

been strengthening relative to the other currencies it is being compared against. (USD, GBP, EUR, CHF,

and SEK) (Please refer to Exhibit G)

Overall, the US Dollar has been depreciating relative to the other currencies. There are many

factors that are held responsible for the fluctuation of the US Dollar in relation to those of other

currencies with the major one being supply and demand. The changes in supply and demand fluctuate

the price of one currency against another one. There are many factors that can affect the supply and

demand of a currency as well as its value.

Economic Factors affecting the US Dollar Economic policy is monitored by the government and it is made up of a combination of fiscal

policy and monetary policy. Fiscal policy can be described as the government spending policies that

influence macroeconomic conditions. These policies affect tax rates, interest rates and government

spending so that it can control the economy. Monetary policies are the actions made usually by the

central bank or even the currency board who determines the size and growth rate of the money supply.

These decisions in turn affect interest rates. In the US, the Federal Reserve is the mediator of monetary

policy. The Federal Funds rate is the rate at which banks are willing to lend money to other banks

overnight. Due to the subprime mortgage crisis, the banks and investment firms could not get the

money needed to cover their short term obligations. The end result was that instead of lending these

banks money at the current federal rate, the US Federal Reserve lowered the rates so that banks could

recuperate and borrow at an affordable rate. However, this only helped them in the short run. There

have been seven rate cuts by the federal reserve in 2008 to help the overall economy. For example, on

March 18, 2008, the Fed lowered interest rates to 2.25% due to the weakening of the economy, slowed

consumer spending, the credit crisis, and subprime mortgage crisis. Most recently, on December 16,

2008, the Federal Reserve lowered interest rates by 75-100 basis points to a range between 0 and 0.25%.

According to the chief investment officer at Harris Private Bank, by keeping a variable rate would

prevent difficulties for money market funds whose fees could outweigh the yields (Federal Reserve

Board, 2009).

Currently, the interest rates in the US is very low and does not attract buying of the US Dollar.

Instead, it often forces people to sell the US Dollar so that they can invest in a different currency that

yields a higher interest rate. Therefore the US Dollar is experiencing low demand which results in its

currency from depreciating. This can be seen in relation to the Euro and also to the Japanese Yen as the

US Dollar depreciates in 2009.

Economic conditions such as inflation can impact a country's fluctuation of currencies.

Currencies that have high interest rate could lead to higher inflation, which could result in a riskier

economy. Most of the time, a currency will lose its value if there is a high level of inflation in the country

or if inflation is assumed to be rising over time because inflation usually hinders the purchasing power

which reduces the overall demand of that currency. As a basic finance course would teach investors

that a higher yield would almost always be accompanied by higher risk. Therefore, investors might be

more risk adverse to their investments and decide to sell them, which reduces the demand for that

country's currency. On the other hand, growing inflation can also lead to the strengthening of the Yen

due to forecasts about possible growth on short term interest rates by the Japanese government to

restrict inflation. In Japan, the interest rate has always been very low. However, the inflation rate has

been steadily rising since 2003 (Please refer to the chart below) and surprisingly, the Japanese Yen has

been appreciating against the US Dollar. The Japanese people have the tendency to be savers rather

than being spenders and I would assume that the Japanese Yen would depreciate as inflation is

expected to increase over 1,600% in 2009 compared to 2008. However, exchange rates are not moved

based on one factor. For instance, Japan has one of the lowest interest rates in the world and a lot of

companies and countries prefer to seek loans in Yen and when it is paid back, it results in a stronger Yen

as more people demand for the Japanese Yen. In addition, there have been several interest rate cuts in

European countries and also the US, which has been a major factor that has depreciated their currencies

against the Yen. Some investors on the other hand are very speculative about the Japanese currency

hoping that it will further appreciate over time. The growing Yen has ultimately hurt exporters the most

and a clear example can be seen in major export companies such as Toyota Motor Corp. Earlier last

week, the CEO of Toyota mentioned that its profits on foreign sales were being affected by the

appreciation of the Japanese Yen (Takahashi, 2009).

Year Inflation rate (consumer prices) Rank Percent Change Date of Information

2003 -.90 % 215 2002 est.

2004 -.30 % 210 -66.67 % 2003 est.

2005 -.10 % 6 -66.67 % 2004 est.

2006 -.30 % 7 200.00 % 2005 est.

2007 .30 % 9 -200.00 % 2006 est.

2008 .10 % 5 -66.67 % 2007 est.

2009 1.40 % 10 1,300.00 % 2008 est.

Source - "Central Intelligence Agency"

A country's economic growth and its health can be seen through employment rates, sales rate,

GPD figures, and etc. Most of the time, a healthy country can be reflected by a healthy currency and its

demand for it. For instance, in the US, the percentage change in GDP has been decreasing since the

middle of 2007 to -3.8% in Q2 of 2009. In addition, the unemployment rate has been also steadily

increasing since 2007 up to 9.8% in 2009. The consumer price index has also dropped dramatically since

middle of 2008 to -1.5% ("Global Economic Indicators", 2009). From looking at these indicators, the US

economy does not represent a healthy economy. In result, the countries around the world are

considering to dump the US Dollar and diversifying their foreign currency holdings as the US Dollar has

been depreciating consecutively. In other words, the diversification of currency essentially means that

the US Dollar will not be bouncing back up anytime soon as countries are losing faith in the US Dollar

(Bloomberg, 2009).

Exchange rates can affect the economic growth of a country which in turn affect a country's

balance of trade. The depreciation of a currency can help achieve a higher economic growth by

stimulating the trade outflows of goods and services. Therefore, trade flows between the countries

signal an increasing need for that currency, which would increase the value of the currency. A country's

balance of trade shows its economy competition through surpluses and deficits. For example, trade

deficits has the tendency to depreciate the value of a currency. In essence, the depreciation of the US

Dollar will improve exports while reducing imports, which will ultimately reduce the overall US trade

deficit. This can be seen recently in the US Dollar as it has been falling constantly and the Obama

administration is trying to reduce the trade deficit as long the depreciation doesn't stop the creditors

from leaving. From the chart below, there is a clear representation of the trade deficit getting smaller

over the years. As the US has long been in a trade deficit, the Obama Administration is striving to

encourage exports to lessen the US trade deficit. The real question is how much the Dollar has to

depreciate to clear the current trade deficit (Bloomberg, 2009).

Source: www.tradingeconomics.com

On the contrary, the Japanese have always traditionally been in a trade surplus. However, it's

fascinating to see that the Japanese currency is also very strong! International business theories state

that a strong currency and an account surplus cannot occur at the same time for a long time because as

the Japanese Yen appreciates, exports should decrease while imports should increase, which would

ultimately reduce the account surplus. However, within the past two years there has only been one

major trade deficit in Japan which was at the beginning of 2009, where Japan experienced one of the

sharpest drops resulting in a trade deficit of 952 billion Yen. ($9.85 billion) The economic report also

showed that during that same quarter, the export levels to the US fell by 52.9%, 47.4% in Europe and

46.7% in Asia, the three biggest export markets, which was mainly caused by the decline in demand for

cars (Takahashi, 2009). Besides the drop in the beginning of January, Japan has always maintained a

trade surplus within the past two years. (Please refer to the chart below)

Source: www.tradingeconomics.com

The basic economic theory in relation to the government's budget deficit/surplus is that the

markets usually react negatively when the government increases its budget deficit and positively when

reducing the budget deficit. This impact is also reflected in the country's currency. For instance, the

current budget deficit of the US is about 11.9 trillion Dollars (Debt to Penny, 2009). In the end, the US

will not have enough to pay back its debt which will ultimately lead to borrowing more money. There

are many negative implications of having a big trade deficit. For instance, large government debts

correspond with high interest rates, which can pressure governments towards policies that will

ultimately boost inflation. This may hurt the investor's confidence in the markets which may possibly

lead to a bear market. Another reason is the fact that as the overall debt increases, the payments will

ultimately come out of the taxpayers' pockets and more taxes will be needed to pay off the debt. This

means that that there will be less money and less flexibility in the amount the government can spend

which would also limit new investment opportunities. If foreign investors perceive the US as a country

that can't control its fiscal policy, they would sell their US investments and look for alternatives in other

countries. This would theoretically weaken the Dollar and could raise future interest rates. From looking

at the US currency, it has depreciated substantially from what it was in 2007. The current interest rate is

already low and the Dollar continues to fall. This suggests that interest rates will increase sometimes in

the future. However, since the credit crisis in 2007, companies are still needing to borrow at a low

interest rate as a higher interest rate would only prevent these financial institutions from borrowing the

money they need to finance their investments.

The implications of having a lower Dollar may help the US lower its trade deficit, however, from

an international perspective, it may hurt a lot of countries around the world. Roughly, there are about

20 countries that are currently pegged to the US Dollar and they are heavily affected by the falling Dollar.

When the US Dollar loses its value, general prices tend to rise and all those countries that have their

currencies pegged to the Dollar also experience inflation in their own countries. This may cause further

problems and through it, countries like Syria have moved on by dropping the Dollar from its reserves

and diversifying it with the Euro and gold. Others have even considered not pegging against the Dollar,

but rather using its own local currencies and the Euros, which reduces the demand of the US Dollar

(Fattah, 2009).

The Response of European & Japanese Companies Foreign companies' are being heavily affected as the US Dollar continues to depreciate.

According to the chief operating officer of Toulouse (incorporated in France), the world's largest

commercial plane maker, announced that the appreciation of the Euro was very difficult for the

company. In addition, as mentioned previously, the vice president of Toyota Motor Corp have also faced

a similar dilemma due to the depreciation of the US Dollar (Bloomberg, 2009). However, the European

and Japanese companies have made adjustments to cope with the changes in exchange rate fluctuations.

For instance, the Japanese companies have managed to maintain strong export sales by cutting the price

of exports and also by shifting production to higher valued merchandise. As mentioned previously, the

appreciation of the Japanese Yen have reduced the price competitiveness of Japanese products and

services that have been exported to foreign countries. According to Exhibit F, Japanese exports would be

more expensive now compared to two years ago in 2007 due to the exchange rate differences. In order

to cope with this change, the Japanese firms reduced their export prices to increase price

competitiveness and to counter the appreciation of the Yen. The rising Yen also helped Japanese

companies to lower export prices as imported goods such as oil and other materials were priced in US

Dollars for instance. Therefore, it was cheaper to import goods denominated in US Dollars. Some

Japanese companies made additional efforts to reduce export prices by cutting the profit margin,

lowering wage rates, and increasing productivity (Klitgaard, 1996).

Another method used by Japanese firms was to shift its products to high value products and

services. The reasoning behind this was that the demand for commodities such as metal is price elastic

or sensitive to changes in price. Therefore, other companies may choose not to acquire the products

from a Japanese firm when the Yen appreciates. On the other hand, offering high value goods are

considered price inelastic such as advanced technology that cannot be acquired elsewhere. Therefore,

consumers are willing to pay a higher price for it or in this case the difference in exchange rates as the

Yen rises (Klitgaard, 1996).

According to a research study conducted by Deloitte, the author suggests should adopt

operational hedging as part of a company's management strategy. Operational hedging is designed to

reduce long term currency risk by allowing companies to be flexible so they can make the necessary

changes to where they manufacture and sell its products. The major purpose of operational hedging is

to monitor the sensitivities between revenue and cost to counter the exchange rate fluctuations while

still holding a competitive position in the markets. Some of the ideas that the author present many ways

to hedge against the fluctuations of exchange rates. For instance, to relocate the manufacturing

warehouses to other markets. This can be seen in the automobile industry, for instance, the European

and Japanese automakers have built manufacturing facilities in the US so that it can receive a constant

stream of revenues in US Dollars during currency fluctuations. Another example is to export its products

into countries with a stronger currency. This way, companies don't need to worry about the

appreciation of its own currency as the strength of the other currency will offset the difference or may

even benefit from it (Mahidhar, 2009). (The strategies mentioned above were also included in

operational hedging suggested by the author: reducing export prices & offering high value products)

Conclusion Throughout the years, exchange rates have always been fluctuating up and down. However,

through the currency project, it was very clear that the US Dollar has been depreciating since 2007. It's

highly probable that this trend will continue in the future. For short term fluctuations, it may be ideal to

utilize financial hedging strategies. However, when exchange rates fluctuates significantly, it is better to

adopt operational hedging strategies. This creates a flexible plan by being able to manage its subsidiaries

while providing efficient management throughout currency fluctuations.

Appendix

Exhibit A

Source: Yahoo! Finance

Exhibit B

Source: www.stockcharts.com

Exhibit C


Exhibit D


Exhibit E


Exhibit F


Exhibit G


Works Cited

Bloomberg. "US dollar rout gains momentum." Brisbane Times. 10 Oct. 2009

<http://www.brisbanetimes.com.au/business/markets/us-dollar-rout-gains-momentum-

20091012-gt5w.html>.

"Debt to the Penny." TreasuryDirect. 10 Oct. 2009

<http://www.treasurydirect.gov/NP/BPDLogin?application=np>.

Fattah , Zainab, and Matthew Brown. "Syria to End Dollar Peg, 2nd Arab Country in 2 Weeks ."

Bloomberg. 10 Oct. 2009

<http://www.bloomberg.com/apps/news?pid=20601087&sid=ahGpyu4D9xBk>.

"Federal Reserve Board." Board of Governors of the Federal Reserve System. 10 Oct. 2009

<http://federalreserve.gov/>.

"Global Economic Indicators." Federal Reserve Bank of New York. 10 Oct. 2009

<http://www.newyorkfed.org/research/global_economy/globalindicators.html>.

Klitgaard, Thomas. "Coping with the Rising Yen: Japanâ€™s Recent Export Experience."

Federal Reserve Bank of New York 2.1 (1996): 1.

Leonhardt, David. "How the U.S. Surplus Became a Deficit." The New York Times. 10 Oct.

2009 <http://www.nytimes.com/2009/06/10/business/economy/10leonhardt.html>.

Mahidhar, Vikram. "Managing in the Face of Exchange-Rate Uncertainty: A Case for

Operational Hedging." Deloitte. 10 Oct. 2009

<www.iasplus.com/dttpubs/0606exchangeratestudy.pdf>.

Mochizuki, Takashi. "Japan Suffers Record Trade Deficit." The Wall Street Journal. 12 Oct.

2009 <http://online.wsj.com/article/SB123554066238668421.html>.

Shachmurove, Yochanan. "A Puzzle Resolved: Japan's High Currency Value and Trade

Surplus." American Economist 43.1 (1999): 47.

"Simply the Web's Best Financial Charts." StockCharts.com. 10 Oct. 2009

<http://www.stockcharts.com>.

Takahashi, Yoshio. "Yen's Rise Dents Toyota Results." WSJ.com. 10 Oct. 2009

<http://online.wsj.com/article/SB125448498910659227.html>.

"Trading Economics." Global Economic Research. 10 Oct. 2009

<http://www.tradingeconomics.com/default.aspx>.

"Yahoo! Finance." Business Finance, Stock Market, Quotes, News. 10 Oct. 2009

<http://finance.yahoo.com>.

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