Global Business: Exchange and Value

Here you are, visiting the ever beautiful London, when you come across a shop with the most beautiful pair of shoes in the window. You notice they’re designer, vintage even, and in the perfect condition, and look, the price says £150. That’s reasonable you say, until you get to the counter to pay for the shoes, only for your mom to point out that £150, is actually $200 in U.S. dollars. This is called an “exchange rate”.

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Yuan Can Become Dominant World Reserve Currency (survey)

from RT.com

The authors of the survey, conducted by the Economist Intelligence Unit and commissioned by State Street financial services, polled 200 senior executives at institutional investors with knowledge of their exposure to yuan assets. Half of the respondents were from the firms headquartered in mainland China (including Hong Kong and Taiwan) and the other half were based elsewhere.

The report accompanying the survey points out that by the end of 2013, the yuan has risen to become the second-most-used trade financing currency and ninth-most-used currency for payments globally.

 

Image from statestreet.comImage from statestreet.com

 

A majority – 53 percent of respondents said that they believe the yuan will one day surpass the dollar as the top currency in international holdings of foreign-exchange reserves. In China 62 percent expressed this opinion, compared to 43 percent of respondents outside the country.

Last May International Monetary Fund analysis showed that the dollar had slumped to a 15-year low, heightening concerns that it may lose that status as global reserve.

Chinese officials are diligently working on sustaining their national currency, promoting it beyond the frontier. In October 2013, the government of China agreed a pilot program to create a UK based yuan hub that allows London investors to buy up to $13.1 billion (80 billion yuan) of stocks, bonds and money market instruments directly, avoiding Hong Kong transactions.

The move gave the yuan a firmer footprint in Europe and helped to overcome the euro in December, becoming the second most widely used currency in global trade.

Only 11 percent of respondents have said that they do not expect the yuan to become a major reserve currency, a split between 16 outside China and six onshore, according to the poll. Among the former, the most often cited reasons are that the yuan will never enjoy enough liquidity across all asset classes to offer a viable option as a reserve currency, and that people will not trust the yuan as a store of value, the survey says.

The very few pessimists from China-headquartered institutions, meanwhile, say that people would be“concerned about future policies of the Chinese government and opposition from other economic powers, such as the US, the EU and Japan.”

But the consensus is that one day it will be a yuan world, according to the survey.

“As China’s economic influence grows, the global importance of the renminbi (yuan) will become magnified. Indeed, while for decades it has been a ‘greenback world’, dominated by the US dollar as the world’s primary reserve currency, many think a ‘redback world’, in which the renminbi enjoys premier status, is increasingly a possibility,” the survey’s authors concluded.

Burgernomics and Lattenomics

World Bank classifies economies on the basis of their gross national income (GNI) per capita. The globalization of economies would necessarily lead to a perfect market situation where in the long run exchange rates should move towards the same price of a basket of goods and services in different countries; that is, a dollar should buy the same basket of goods and services everywhere in the world. This is called purchasing power parity (PPP).

The Economist newspaper has derived a couple of innovative ways to measure the shift towards a more globalized world. The Big Mac Index was introduced in 1988. The Big Mac is produced in more than 120 countries. The theory of PPP will suggest that hamburgers cost the same in Asia as in other continents. Comparing actual exchange rates with PPP will thus provide an indication of whether a currency is under- or overvalued.

The newspaper subsequently introduced the Starbucks Tall Latte Index, in order to further test the theory of PPP. By coincidence, the average price of a Starbucks tall latte in the U.S. was the same as the average price of a Big Mac — USD 2.80 — in 2004. It turns out that the Tall Latte Index tells broadly the same story as the Big Mac Index for most key currencies. The indices show that the euro is about 30 percent overvalued against the dollar. This is based on the average price of EUR 2.93 — USD 3.70 — in member countries where Starbucks operates. Sterling pound is also 17 percent overvalued. Both indices show that the Swiss franc is the world’s most overvalued currency. The Canadian, Australian, and New Zealand dollars are still undervalued against the dollar despite their recent climb.

The indices, however, show mixed results when it comes to Asian currencies. The Big Mac Index says the yen is 12 percent undervalued against the dollar while the Tall Latte Index suggests that it is 13 percent overvalued. More startling is the Chinese yuan. It is 56 percent undervalued according to the Big Mac Index, but spot on its dollar PPP according to the Tall Latte Index. The differences probably reflect the different nature of competition in the markets for the two products: Starbucks coffee is pitched as a lifestyle drink and hence commands a premium, especially in Asian economies.

For more information, refer to Fundamentals of International Business: 1st Asia-Pacific edition by Michael Czinkota et al. 

 

G-20 in Russia: Currency Wars

The Group of Twenty (G-20), consisting of industrialized and developing nations, has been prominent in dealing with current economic crises.

Talks took place in Russia February 15th and 16th addressing the current currency wars. Brazilian Finance Minister Guido Mantega commented, “The currency war has become more explicit now because trade conflicts have become sharper. Countries are trying to devalue their currencies because of falling global trade.” That way, exports become more competitive while imports will be reduced.

The U.S. along with other developed nations tend to use quantitative easing as one of their main stimulus measures, in which a central bank buys assets such as government bonds using freshly created money. This results in increasing the supply of currencies such as the U.S. dollar and the U.K. pound; thereby, in the long run, lowering their exchange rate.

The G-20 pledged to “refrain from targeting their currency policies to gain a competitive advantage.” All nations agreed to defuse tensions over unstable exchange rates, marking the first time they were in agreement on such an issue. If all were to engage in competitive devaluation, no country would benefit.

These talks prove G-20 members are moving toward more cooperative efforts. This will help lead the path to global economic growth, which in effect, may help increase U.S. exports and its domestic economy.

 

Source: http://online.wsj.com/article/SB10001424127887324162304578307320045470086.html?user=welcome&mg=id-wsj

Are You Prepared For A New Surge of Countertrade?

International exchanges of goods and services are typically conducted with currencies, the value of which is settled by the four legs of trust, demand, supply, and risk. If any of these legs are weakening, substitute exchange methods emerge, based on precious metals, commodities or even cigarettes. In light of economic and financial volatility in the U.S., Europe and parts of Asia, we may again be heading for such substitutions in the global market.

Interest rates now underprice the true cost of capital. Global financial shifts around the world are frequent, easy, and large scale. Government debt repayment is uncertain. Currency blocs such as the Euro are exposed to significant stress. The choice of the U.S. dollar as reserve currencies may be shifting. Financial debt and exposure are increasingly imbalanced. As a result of all these instabilities, barter, buybacks, offsets and other forms of countertrade re-appear in the global market, offering new efficiencies in the conduct of trade. Companies need to understand how such international shifts will affect them, and learn to adjust their marketing and financing approaches to these new opportunities.

Countertrade is the use of goods, services, and other non-monetary resources as payment. Recent discussions with the Global Offset and Countertrade Association indicate that countertrade is on the rise due to government and company requirements.

Governments are concerned about the influence of large transactions on their country’s balance of payments. They increasingly demand ‘offsets’ which are designed to reduce such influence. For example, in order to help pay for the acquisition of military airplanes, a country may demand that the seller of the planes encourages tourism to the country – as done by Egypt. Concern is also growing about structural trade deficits. Governments and companies make countertrade a condition for importers. For example, Zaire and Italy exchanged scrap iron for 12 locomotives. China traded Russia 212 railway trucks full of mango juice in exchange for a passenger jet.

We like to think that only the free market sets prices. However, government influence and international necessity often build result in significant barriers to international exchanges. Countertrade agreements have shown that an exchange of goods for goods can overcome currency problems. Historically, countertrade was used by soft currency countries, particularly in times of the Soviet Union. It has begun to rise again since the 2008-2009 financial crisis, bridging currency gaps and helping to reduce vast inventories. On a global scale, countertrade capability provides firms with a competitive edge. It keeps transactions alive and reduces the fear of high currency volatility. Many firms just want to carry on their business, rather than become currency speculators.

Companies know that an acceptance of non-cash payments can affect product values negatively. But as an alternative to no trade at all, countertrade looks better every day. Take the realities of a recent countertrade deal between Argentina and South Korea. Argentina reported a trade deficit of $6 billion in 2010, driven in part by high automotive imports. Argentinean imports from the South Korean car company Hyundai alone amounted to $91 million with consumer demand for cars growing. Historically, the government handled such situations by simply refusing more imports. But international agreements and negotiations have sharply reduced this option.

The Financial Times reports that Argentinean Hyundai distributors will utilize countertrade to compensate for the negative effects of car imports from Korea. They will stimulate the Argentinean sales of agricultural goods, specifically peanuts, wine, and soy flour to South Korea. Economic hardship is not the only incentive to countertrade. Bilateralism plays a large role in the acceptance of a countertrade offer. A country may encourage its companies to accede to barter requests from foreign trade partners and allies. The link between business and politics encourages such accommodation, even though doing so may be inconvenient. In the future, trading partners may reciprocate.

After decades of dormancy, countertrade is on track to again become a vital part of the global market. In a world of economic hardship, parsimony, and growing currency uncertainty, countertrade emerges as a viable solution for market and political shortcomings. Companies are well advised to re-cast their strategy to reflect countertrade expectations and requirements. On the outreach side, new marketing and financing packages need to be prepared in order to remain ahead of the competition. Internally, personnel needs to be hired and trained, to initiate such transactions, supervise them and see them through to long term completion. Banks need to prepare for countertrade based financing and get ready to help clients use countertrade.

In sum, we all need to get out of the headlight of currency weaknesses and changes, and prepare for the resulting shifts in the conduct of international business.