Monetary Policy and Business

The US Federal Reserve (The Fed) recently announced that it would cooperate with the European Central Bank (ECB) to lower the borrowing rate of swaps in order to help ease liquidity in the European markets.  "The plan is to reduce the cost of loans between central banks -- these are known as liquidity swaps -- so that dollars are cheaper to obtain.[1]” In the face of uncertainty, local currency credit markets are tightening in the Euro area and the dollars are meant to help allow banks continue operations.

It is these types of actions by central banks that can have significant impact upon businesses and in fact have become more common since the start of the global recession in 2008.  Think of the Quantitative Easing programs (QE) that the US, the UK, and EU have undergone[2], or the US contention that China keeps its currency artificially low.[3]  

All of these programs cause exchange rates, and therefore the price of goods, to fluctuate rapidly and unpredictably causing significant impact to supply chains, payroll checks, loan repayments, capital expenditures, and other aspects of normal operation.  "In 2006, a survey ...found that 80% of corporations surveyed acknowledged that their businesses were exposed to significant foreign exchange risk. However, only 42% of these corporations indicated they employ currency hedging techniques to manage risk."[4]

Even worse, the recession provides an incentive for central banks to engage in these programs as a method of making domestic goods cheaper abroad in order to obtain growth, effectively "stealing" growth from other countries as those products become more expensive.  Occasionally, this may result in "economic warfare"[5] where countries react to the monetary actions of another.  Again, this means increased uncertainty for global firms and academic studies suggest that even in the best of times, currency risk is not compensated with higher returns.[6]

In order to mitigate these currency risks, global firms should:

• Perform a complete supply chain analysis.  Firms can use technology and business intelligence to identify key components of their portfolio of raw materials.
• Look for over-exposure of raw materials from one country or one currency and then analyze the risk of that currency due to domestic policy as well as economic stability.  Also included in that risk are ripple effects of policy/ economic variables in markets that the supply market is dependent on. 
• Identify materials in the supply chain that may be dependent on the value of a currency, like oil, that will require hedging strategies such as futures and options.   This may also be a good time to perform a sustainable supply chain analysis in order to identify raw materials that are risk from environmental impact or regulation. 
• Finally, if the firm itself is a step in someone else’s supply chain then they need to analyze how currency risk can affect their customer’s desire or ability to continue purchasing. 

• Perform a customer segmentation analysis.  Again, technology and BI can help a firm segment their customers to identify if large portions are in markets at risk and how it may impact sales.
• Identify overexposure to clients that pay with volatile currencies. 
• Just because customers may be using the same currency as the manufacturer, if the manufacturer’s customer’s customers are unable to operate because they are tied up by currency swings, then that will impact that manufacturer as well.

• Identify other parts of the firm that operate abroad or are dependent on foreign exchange. Many firms today have divisions, such as call centers and manufacturing plants, which operate in a different market than HQ.  Firms need to analyze the risk to these operations in the case of a significant currency price swing that may affect payroll or capital expenditures.   

• Look at the balance sheet to determine specific assets and liabilities. Firms that have borrowed money or lend money (even within their own firm but to divisions in other countries) face challenges with currency swings.  Using standard financial services principles, a firm can look for risk to Accounts Receivable or identify liabilities they may need to renegotiate. 

• Maintain extra cash on the balance sheet.  Successful companies in past recession have kept "3 to 10 times the normal level of cash assets on their balance sheet[7]", but those recessions were neither as deep nor as long, and did not have the increased volatility of system of tit-for-tat by central banks.  Maintaining extra cash is a necessity in order to prepare for shocks. 

• Hire a risk mitigation specialist.  Whether in-house or external, if the firm buys or sells goods in multiple countries, has operations, borrows or lends money, stores money in banks, or invests in multiple countries, then they need a specialist who knows how to use hedging tools such as derivatives.

[1] http://www.cbsnews.com/8301-505123_162-57333882/will-the-feds-move-to-help-europe-hurt-the-u.s./

[2] http://en.wikipedia.org/wiki/Quantitative_easing#After_2007

[3] http://www.bloomberg.com/news/2011-11-14/obama-says-enough-s-enough-on-china-s-undervalued-yuan-as-hu-pushes-back.html

[4] http://www.slideshare.net/wugbp/currency-hedging-strategies-western-union-gbp

[5] http://www.bbc.co.uk/news/business-11608719
[5]http://www.amazon.com/Currency-Wars-Making-Global-Portfolio/dp/1591844495/ref=sr_1_1?s=books&ie=UTF8&qid=1322972520&sr=1-1

[6] http://www.investopedia.com/terms/c/currencyrisk.asp#axzz1fDgo3FY5

[7] http://www.npr.org/2011/11/28/142839186/should-ceos-have-to-buy-company-stock-with-their-own-money