QC Newsletter

December 8 , 2010

Who Cares About the Dollar?

Maybe a better question would be: Does the Dollar’s strength or weakness really matter?

I’m sure you have seen the press reports about the President’s visit to Asia and his inability to get concessions on currency valuation from China. We’ve written about this to some extent in the past (August, 2010, QC Newsletter) but it is a situation that continues to fester. Or does it?

When China said they would allow the Yuan to revalue by as much as 15 percent in the summer, my first impression was that this would be good for U.S. industry and the contract manufacturing portion in particular. If you look at a chart of the Yuan to Dollar rate, it is clear that something did happen around that time, but it wasn’t much. For years, the Yuan was at about 6.84 to the Dollar. As of today (November 29) it is at 6.66. That’s about a 2.6 percent revaluation. It’s unlikely that a change of that small magnitude will cause any meaningful shifts in trade.

But what has happened to other currencies over this period? Take the Euro for one. In the summer, the Euro hit a high of about 1.19 to the Dollar. As of today, it’s at 1.31. That’s about a 9 percent DEvaluation. We haven’t heard much complaining about European cheap imports flooding the U.S., but there are other macro factors influencing this as well. The likely culprit is the serious debt crisis that seems to linger in pretty much every country in Europe except Germany.

What about Japan? The Yen has gone from about 92 to 84.3 to the Dollar over the same time scale. That is about 9.1 percent gain against the Dollar and reflects continuation of a long-term process. No wonder the Japanese car companies have so consistently increased their U.S. plant capacity. One would think that the Yen should soften given tough demographics and fiscal stress in Japan, but it does not seem to be happening.

So what does it mean?

Ability to borrow? National pride? Taken in isolation, currency has little meaning. The main question is what will my Dollar buy? If the answer is “not much,” then we have a problem. But that does not seem to be the case. Would it be better to go back to a period when the dollar was stronger, but a pair of cheap pants cost $90?

Another question is: If a Dollar isn’t worth much, why does China hold so many? At least now, the Dollar is a better bet for the Chinese than other currencies or the Yuan. One can argue that the Dollar is far safer than the Yuan due to the greater difficulty in manipulating it. Same can probably be said for the Euro, Yen and Pound. Why don’t foreigners buy and hold a lot of Yuan?

Commodities are being impacted. Gold recently hit an all-time high in dollars. I remember when it hit $840 (and stayed there for about a week before falling back into the $600s) about 30 years ago, never to get close again until the current run-up. But interestingly, if you assume a 3 percent average annual inflation rate, the $840 peak would be over $2000 in today’s Dollars. Even $600 would correspond to about $1400 today. At least one lesson is that trees don’t grow to the sky. Another is that betting on commodity prices to outrun inflation may not work over the long run.

China, although a source of many finished goods, is also a source of raw materials used in many industries, including our own. Things such as semiconductors, passives, relays and magnetics are all heavily sourced in China. So with a Yuan revaluation, Chinese labor may get more costly relative to other locations, but so will all those parts. Even with a large revaluation of the Yuan, many of the costs we see over here will be higher and could prove detrimental depending on a given company’s mix of purchased items.

My conclusion is that despite trade imbalances, lots of borrowing, and other economic problems, many countries prefer to do business in the U.S. and trade in Dollars. Despite our difficult current economic situation here, we’re still better off than most other places. Thus people still want Dollars—the more the better.

--Jeff Cosman