Whether we’re in a booming economy or facing a recession, finance experts always relate what is happening to the strength of the dollar. A weak dollar impacts our buying position, as we are forced to pay more for the same imported product. This is particularly important for U.S. businesses who need to source components in Euros or other currencies. This can be a complex issue to understand, so here we’ll delve into the topic a little further and explain how a strong versus weak dollar affects U.S. businesses.
The reasons for a weak dollar
A weak dollar refers to a lower U.S. dollar value compared to other currencies. For example, if the exchange rate is $1 to €0.80, and then it changes to $1 to €0.90, the dollar has weakened against the Euro. There are a number of reasons why this may occur.
The first reason why the dollar may weaken is monetary policy. The Federal Reserve (the Fed) implements policies to adjust interest rates. When the Fed implements quantitative easing measures or lowers the interest rate to encourage people to borrow money and stimulate the economy, this can weaken the dollar. Since 2008, both conditions are met — interest rates are very low (at an all-time low most of the time), while the Fed injected trillions of dollars into the financial markets. Due to the pandemic and its impact on the U.S. economy, the FED printed money more than ever before.
And this brings us to the next reason for a weakened dollar: inflation. Generally, higher inflation depreciates currency, as the cost of goods and services are higher. Likewise, the dollar can be weaker when the prices of exports fall. For example, oil is a major export for Canada, so when oil prices drop, the Canadian dollar weakens.
Implications of the weak dollar for businesses
A weak dollar has less buying power against other currencies, and this can have numerous implications for both consumers and businesses, but not all are negative.
Imports and exports: A weak dollar means that imports are more expensive, but conversely, exports are more attractive to buyers outside the U.S. So, for businesses that import components or products in another currency, their costs will increase. However, if your business exports goods overseas, you may find that there is an increased demand.
Increased expenses: Even if your business does not import or export, you may still experience increased expenses. There are items that tend to have a greater susceptibility to a weak dollar, such as gasoline, travel, and commodities. So, if you need to purchase plastics or need fuel for your machinery and vehicles, a weak dollar could impact your bottom line.
Stock investments: If a company is sensitive to movements in dollar value, it can also impact stock value.
Increased lending potential: When the dollar is strong, it can exert a drag on the U.S. economy. This achieves similar results to a tighter monetary policy, such as increasing interest rates. Conversely, when the dollar is weaker, interest rates tend to be lower. This increases the lending potential for consumers and businesses.
More flexible credit terms: This is a continuation of the above point, but lenders may also offer more flexible credit terms to entice borrowers when the dollar is weak. So, you may not only qualify for a more attractive rate but also offer fewer restrictions and more favorable terms if you sign up for a new finance agreement.
Changes to consumer spending: Since a weak dollar increases the cost of imported goods, it can lead to reduced consumer spending. Retailers may increase the price of other products to compensate for decreased sales and to generate more revenue. Consumers may take steps to tighten their belts and be reluctant to purchase non-essential or luxury items.
Pressure to increase wages: Employers may also find there is pressure from employees to increase wages. Employees are likely to want this to offset the increases in the prices of consumer goods. If you are unable to give your employees a raise, you may find that team cohesion and satisfaction diminishes.
Which type of businesses will benefit? Which will be hurt?
Since there are both positive and negative implications of a weak dollar, it can affect different businesses in different ways. Some businesses will benefit from a weak dollar while others will be hurt.
The types of business that can benefit from a weak dollar are those that cater to the domestic market. If you produce items in the United States with domestic materials and don’t export, the weak currency will have minimal impact on your day-to-day profitability. Additionally, businesses that are primarily foreign stock market-based, can also benefit. When the dollar falls, it increases the value of your foreign stocks once they are converted into dollars.
If you operate overseas and the foreign currency is strong against the dollar, you can also benefit from a weak dollar. Your profits will be in foreign currency, and when converted, you’ll get more return on your dollar.
However, businesses that have a focus on luxury items or imports are more likely to feel the financial pinch of a weakening dollar more than others. For example, when the dollar is weak, people are less likely to take a foreign vacation, so travel agencies will lose business. Additionally, car dealerships that sell imported vehicles, retailers selling imported goods, or jewelers that depend on imported diamonds are likely to see business fall.
Unfortunately, even a business that should be stable, regardless of currency fluctuations, can be affected in indirect ways. For example, a U.S. business producing domestic items may still have to cover the increasing costs of fuel and may still feel financial pressure from their employees who are struggling to pay the increasing cost of imported items.
What business owners can do to protect themselves?
Most U.S. business owners are more likely to be affected by the transaction risk of fluctuating dollars. This type of risk applies to company payments made or received in foreign currency. If the currency fluctuates, you may still be obliged under your contract to pay in less favorable conditions.
Fortunately, business owners can protect themselves by adopting a hedging strategy approach. Hedging strategy helps businesses to avoid rolling the dice when they sell overseas, buy from foreign suppliers, or produce products outside of the U.S. It offers advantages including reducing uncertainty and providing protection against any unfavorable currency movements. This allows you to protect profit margins, and focus on your core business.
There are several options for hedging that can reduce or eliminate the foreign currency risk exposure to help businesses to navigate any periods of heightened volatility better:
Forward contracts: Forward contracts are agreements between parties to buy and sell a specific amount at a rate established ahead of time. This can be set with an open or closed date, allowing businesses to hedge against currency movements. However, it is a firm commitment that once established, cannot be canceled.
Currency swaps: Currency swaps are cash flow management tools that are a popular option for businesses with foreign currency outflows and inflows at different dates. It can be used to resolve problems matching foreign currency cash flows to move up or extend contracts or prevent any unproductive surpluses. However, a business cannot capitalize on a favorable currency movement and you cannot cancel the swap.
The classic option: The classic hedging option allows businesses to buy or sell currency at a rate set ahead of time. This acts a little like insurance against unfavorable currency movements. However, you do need to pay a premium for this protection.
Commodities/crypto: This option is risky. However, we already see many businesses investing in cryptocurrencies, and as time goes by, more businesses are joining the trend. However, cryptocurrencies are extremely volatile. Commodities—especially gold—can be a great investment hedging against inflation.
Even if your business is not impacted by imports and exports, your bottom line could still be impacted by a weak dollar. If your expenses increase, you need to think about possible strategies you could use to counteract this trend. In many cases, this may be something as simple as having an emergency fund, but you may also need to plan possible pricing increases into your overall business plan.
Currency fluctuations can have a massive impact on consumers and businesses. Some businesses are more susceptible to currency movements, but since it has wider implications across the economy, it should be something that all businesses consider.
As a business owner, you’re likely to be aware of the importance of being flexible, but you may want to add some contingencies into your business plans. This will allow you a margin to cover any increased running costs that may occur as a result of the dollar dropping in value.
Opinions are on our own. The information is provided for information only and does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell, or otherwise transact in any investment including any products or services or an invitation, offer or solicitation to engage in any investment activity.