Dollars, Not Bananas
“The Dow Jones Is Measured In Dollars, Not Bananas.” I would like to thank Peter Schiff, President of Euro Pacific Capital, for brightening up my day and giving us the quote of the week. Peter’s “dollars, not bananas” explanation summed up nicely two of last week’s biggest stories.
On Wednesday, the Dow Jones industrial average plummeted 361 points, or 2.6 percent, as the U.S. dollar fell to an all-time low relative to the Euro and was sharply lower against other currencies, “As the dollar loses value, U.S. stocks lose value,” Peter elaborated.
Closer to home, my head of sales and marketing called me excitedly from a customer meeting on Thursday. It seems he had also noticed the sharp sell-off in the dollar, and suggested that we include currency as a topic in our upcoming general managers’ meeting. We have more than a passing interest in all of this since we export to both the United States and Europe from China.
It is true that the dollar and the Euro have taken entirely different paths this year. In the quick analysis that we have done, the Euro has appreciated by 6 percent against the yuan in 2007, while the dollar has declined by 5 percent, dropping below 7.45 to one Wednesday.
As with most occurrences in the global economy these days, at least a partial explanation for what is happening can be found in China. Clearly, one of the reasons for the dollar’s decline is that the Federal Reserve keeps lowering interest rates, as one measure to counter the aftershock of the sub-prime mortgage crisis and prevent the U.S. economy from falling into recession. But the other is that the Chinese government is obviously diversifying the investment of its huge hard currency reserves away from U.S. dollar holdings and into Euro denominated investments.
While officials in the United States were quick to deny that this is indeed happening, top Chinese officials suggested last week that they would begin to direct more of their future reserves into European assets. With the value of the dollar dropping against the Euro, why wouldn’t they? Since mid-August, the price of a dollar has dropped from 0.75 Euros to 0.68 Euros. (Conversely, the price of a Euro has risen from $1.34 to $1.46 during this period.)
What does this mean to someone doing business on the ground in China? Quite simply, it means that currency is becoming an increasingly important consideration, which is why my head of sales and marketing suggested that we add it to our meeting agenda. Until something changes, I have to assume that the dollar will be depreciating at least five to seven percent per year against the yuan for the foreseeable future. That means that we have to enforce the currency/price adjustment provisions that we now routinely include in our export contracts. Otherwise, we will be giving automatic five to seven percent annual price reductions to U.S. customers. (That is why many economists worry that the fall in the dollar will mean higher inflation for U.S. consumers.) It also makes me more interested in developing further our European export business. (That is why European policymakers are becoming increasingly worried about their own trade balances with China.)
On a broader level, we will see what impact these currency adjustments (assuming they keep trending in the same direction) have on the massive U.S. trade deficit with China. For the past several years, U.S, politicians have attributed China’s competitiveness to the country’s currency policies. With the dollar’s decline against the yuan now accelerating, the validity of their allegations will be tested. My guess is that they will be surprised by the answer.
