The Weak Dollar Shuffle
MiBiz • January 12, 2004
by Jim Gillette
Here we go again! Changing currency values are reshuffling the competitive landscape in the auto industry.
From the spring of 1995 to early 2002, the strong dollar shifted the competitive pricing advantage to European and Asian imported vehicles, auto parts and raw materials while making exports tough to come by. Currency valuations have since dramatically changed direction.
Relative to the euro, the dollar declined nearly 17% in 2003 and nearly 28% over the last two years. Due to strong intervention by the Bank of Japan, the dollar has lost less value vis-à-vis the yen, down about 10.5% this year, but more about that below.
The plummeting value of the US dollar is one of those classic “good news, bad news” stories. Exporters love a cheap dollar while consumers and the Federal Reserve hate the higher prices it eventually brings.
Domestic automakers win by standing still
The domestic Big Three automakers (and the UAW) will be clear winners in the near-term as foreign competitors are forced to raise prices. It’s something like an unexpected gift where cars and trucks assembled in the US with high domestic content gain some pricing advantage without moving a muscle to lower costs or improve productivity.
The last time the dollar weakened on this scale, the leading Japanese automakers redoubled their efforts to lower costs without sacrificing content. By the mid-1990s, Toyota was said to be able to show a profit even at an exchange rate of 80 yen = $1. At the current level of 107 yen = $1, strong players like Toyota, Honda, and Nissan are raking in the dough.
When currency values do another about face (and they eventually will), highly efficient foreign-based manufacturers will all that better positioned. It’s an open question as to whether the Big Three will squander another opportunity to rebuild profitable market share this time around.
Suppliers are in a good position to take advantage
After being pummeled for years by automaker cost-down requirements, the majority of US suppliers are in good position to take advantage of their more price competitive position vis-à-vis imported components. The adoption of lean manufacturing processes and the reduction of labor content have made US suppliers among the most competitive in the world when it comes to high value-added content when labor is only a minor portion of total cost.
The best long-term hedge against currency fluctuations is to build product in the country where you intend to sell it. This strategy has been employed by Japanese manufacturers over the last twenty years and will be adopted more and more by the Europeans doing business in the US.
Weak dollar = higher oil prices
One offshoot of the weak dollar that negatively affects consumers and business alike, however, are higher oil prices, currently well in excess of $30 a barrel (West Texas Intermediate crude). Although there are a number of factors in play, not the least of which is the rise in worldwide demand led by China’s emerging thirst for energy, the dollar’s decline has played a role in our paying more for oil and gasoline here in the US. Since oil is priced globally (with a few exceptions) in dollars, when the dollar’s value declines, produces respond by raising the dollar price all else held equal.
While oil prices in the US have jumped over 22% since May 1 (near the “end of hostilities in Iraq”), Europeans have experienced only a 10.8% increase when the price is converted to euros. The dollar price of oil in the US was unchanged comparing the price on Jan 2 last year to the price on December 23, yet the euro price of a barrel declined 16.5% for the same dates. This presents a nice stimulus for the Europeans compared to an economic drag for the US. It also affects the pricing of materials using petroleum as feedstock, plastics, for example.
So, what is causing the dollar’s decline and will it continue to fall in value?
Currency markets can be extremely volatile and are notoriously difficult to forecast. We often read currency forecasts issued by highly paid Wall Street “experts” only to see the opposite of their predictions occur within a matter of weeks or even days. We can gather some clues, however, by looking at the trends underlying movements in currency values.
The relative strength of one country’s currency verses another’s results from three factors: the balance of trade (exports minus imports), the comparative rates of inflation, the difference between real (inflation adjusted) interest rates, and intervention by monetary authorities to temporarily adjust currency values.
The trade deficit is the biggest problem
A sharp deterioration in the trade balance has been perhaps the most significant cause of the dollar’s recent decline. The US balance of trade on current account, that is goods and services sold to foreign buyers minus goods and services bought by US buyers has surged to an annual rate of well over $500 billion. That translates to about $1.5 billion per day or 5% of GDP!
The last long-term cycle of dollar strengthening that began in the spring of 1995 fueled a voracious appetite for foreign-made goods, not the least of which were imported cars and trucks. Rising prices of imported goods will eventually counter consumer demand. Improved price competitiveness will eventually increase export demand. The operative word is “eventually” as consumers will continue to buy even more expensive imports for a while. This will exacerbate the trade deficit in dollar terms until exports catch up and consumer switch to domestic goods.
Two of the other factors, relative prices and inflation-adjusted interest rates moderately favor a weak dollar, but currency intervention on the part of some Asian countries to keep their currencies weak relative to the dollar has been counteracting some of the dollar’s weakness.
The Bank of Japan, for example, spent about $170 billion in 2003 selling yen and buying dollar-denominated securities in order to prevent the yen from appreciating any further in value. This was an all-time record for any central bank spending for currency intervention. Intervention would stop if the countries doing it ran out of dollar reserves needed to buy dollar denominated financial assets. Don’t count on this anytime soon, as our trading partners have built up huge dollar reserves as a result of out trade deficit.
Foreign automakers are increasing their North American assembly capacity by over 1 million annual units, predominantly in the southeastern US. It is in their long-term best interest to source as much content here in order to avoid future risk of currency fluctuation. Global tier ones, like Bosch, Valeo, and ZF will also be looking to shift systems and module production to the US, especially when they have flexibility built-in to their plants that enables a rapid production shift away from strong currency countries to weak currency locations.
Be sure you are positioned to go after this business!