Cross-Border
US Dollar Dominance: A blessing and a curse (Part I)
US Dollar Dominance:
A blessing and a curse (Part I)
Many pundits and prognosticators are predicting the impending collapse of the US dollar as the world’s reserve currency. While the reality is that that collapse may not be imminent, US dollar dominance is both a blessing and a curse for US-based businesses.
The blessing. The US dollar is one of the most widely traded and accepted worldwide. The cost of capital is often much lower. These factors can reduce risk to US businesses from currency fluctuations.
The curse. The added convenience of USD fungibility ignores many ‘macro factors.’ The USD’s centrality means it’s highly sensitive to market volatility. ‘Hidden’ volatility, though, can make it more challenging to recognise and account for fluctuations in the balance sheet. This can expose businesses and their international operations to greater transactional and translational risk, affecting profitability.
So? Accounting for FX risk by evaluating pricing, profit and loss in both USD and local currencies could illuminate hidden exposures, and can help inform better hedging decisions.
Corpay has tools and resources to help support your planning. To learn more, please read on or contact me for a chat.
Much has been made about the impending collapse of the US dollar, and the central role it plays in the global economy. The reality, however, is that the USD is likely to maintain its dominant role in global trade and finance for the foreseeable future. This presents both a blessing and a curse for US businesses operating internationally.
The ‘blessing’
Firstly, for a US-based business, USD dominance can make life a lot easier. Customers and vendors abroad are often more than willing to accept USD, obviating the need for the business to consider accounting for foreign currency needs, or for the direct impact FX fluctuations might have on financial performance. It also makes life a lot easier when considering banking and payment data requirements: they’re minimal, and you rarely have to consider another country’s specific tax and banking code requirements when sending a USD wire.
Secondly, and often overlooked, is the ease at which capital can be accessed in USD. The centrality of the US dollar as the global reserve currency ensures a cost of capital that is often far lower than what the corporate sector in other countries might face. In large part, this supports the ability of the US consumer to consume.
The ‘curse’
But US dollar dominance can be a double-edged sword. This emanates from macro-factors we will explore in two weeks’ time, but the bare fact is that that added convenience can come at a cost often not immediately apparent to US businesses operating across borders.
The ‘curse’ of US dollar dominance is that often businesses are exposed to hidden FX volatility, which is much more difficult to quantify.
What do you mean, I am exposed to FX volatility?
Due to its centrality in global trade and finance, the US dollar is actually quite a volatile currency relative to its peers. While this volatility may not show up directly in the financial statements of all US businesses, it can still have an impact.
When FX exposures are apparent to financial decision makers, as in the chart below, the nature of the exposure and where it falls on the financial statements is easier to define. From here it’s straightforward to build FX into a business’ FP&A, and ultimately to take steps to mitigate the impact of FX volatility.
The following tracks the USD Trade-Weighted Index over the past ten years, and illustrates the US dollar volatility.
Hiding in plain sight
In our experience, hidden FX exposures fall into three broad varieties.
1. USD-denominated intercompany transactions
A US parent contracts with a Chinese or Mexican subsidiary for manufactured goods. Transactions are denominated in USD, but costs are based on the local currency price. Thus FX fluctuations directly impact COGS and gross margin.
US parent sells to EU based subsidiary. USD fluctuations impact the subsidiary’s profit and loss statements (P&L), which ultimately gets rolled up to the parent on consolidation.
2. Foreign subsidiary’s transactional FX risk
Foreign subsidiary sells in USD. Selling, General and Administrative expenses (SG&A) are in local currency. This impacts the subsidiary’s profitability, which ultimately rolls up to parent on consolidation.
3. Third-party transactions in USD
Paying and pricing in USD. It is common for many US businesses to pay foreign vendors or to price their foreign sales in USD. This is convenient as it pushes FX risk to the third party. The downside is it can result in higher expenses, increased credit risk, and less economic competitiveness.
What you don’t know…
Being able to evaluate expenses, liabilities, and inflows in both US dollar and the local currency could help uncover some of these ‘hidden’ exposures. Bringing them out of the shadows can help you to make more well-considered decisions about your hedging strategy.
The more you know, the more confident you can be in your planning.
In our next post, we’ll take a closer look at the dynamics of US dollar dominance.
Corpay’s General Treasury Team can assist in your identification and quantification of these ‘hidden’ FX exposures and support execution of your strategy.
Would you like to discuss this further? Let’s schedule a chat about how we can tailor the analysis to your business!
Please note: Opinions expressed in this article are those of the author. Please contact an independent advisor to ensure that solutions discussed here are right for your business.
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