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Whether we’re in a booming economy or facing a recession, finance experts always relate what is happening to the strength of the dollar. A weak dollar impacts our buying position, as we are forced to pay more for the same imported product. This is particularly important for U.S. businesses who need to source components in Euros or other currencies. This can be a complex issue to understand, so here we’ll delve into the topic a little further and explain how a strong versus weak dollar affects U.S. businesses.
A weak dollar refers to a lower U.S. dollar value compared to other currencies. For example, if the exchange rate is $1 to €0.80, and then it changes to $1 to €0.90, the dollar has weakened against the Euro. There are a number of reasons why this may occur.
The first reason why the dollar may weaken is monetary policy. The Federal Reserve (the Fed) implements policies to adjust interest rates. When the Fed implements quantitative easing measures or lowers the interest rate to encourage people to borrow money and stimulate the economy, this can weaken the dollar. Since 2008, both conditions are met — interest rates are very low (at an all-time-low most of the time), while the Fed injected trillions of dollars into the financial markets. Due to the pandemic and its impact on the U.S. economy, the FED printed money more than ever before.
And this brings us to the next reason for a weakened dollar: inflation. Generally, higher inflation depreciates currency, as the cost of goods and services are higher. Likewise, the dollar can be weaker when the prices of exports fall. For example, oil is a major export for Canada, so when oil prices drop, the Canadian dollar weakens.
A weak dollar has less buying power against other currencies, and this can have numerous implications for both consumers and businesses, but not all are negative.
Related: The High Cost of a Low Dollar
Since there are both positive and negative implications of a weak dollar, it can affect different businesses in different ways. Some businesses will benefit from a weak dollar while others will be hurt.
The types of business that can benefit from a weak dollar are those that cater to the domestic market. If you produce items in the United States with domestic materials and don’t export, the weak currency will have minimal impact on your day-to-day profitability. Additionally, businesses that are primarily foreign stock market-based, can also benefit. When the dollar falls, it increases the value of your foreign stocks once they are converted into dollars.
If you operate overseas and the foreign currency is strong against the dollar, you can also benefit from a weak dollar. Your profits will be in foreign currency, and when converted, you’ll get more return on your dollar.
However, businesses that have a focus on luxury items or imports are more likely to feel the financial pinch of a weakening dollar more than others. For example, when the dollar is weak, people are less likely to take a foreign vacation, so travel agencies will lose business. Additionally, car dealerships that sell imported vehicles, retailers selling imported goods, or jewelers that depend on imported diamonds are likely to see business fall.
Unfortunately, even a business that should be stable, regardless of currency fluctuations, can be affected in indirect ways. For example, a U.S. business producing domestic items may still have to cover the increasing costs of fuel and may still feel financial pressure from their employees who are struggling to pay the increasing cost of imported items.
Most U.S. business owners are more likely to be affected by the transaction risk of fluctuating dollars. This type of risk applies to company payments made or received in foreign currency. If the currency fluctuates, you may still be obliged under your contract to pay in less favorable conditions.
Fortunately, business owners can protect themselves by adopting a hedging strategy approach. Hedging strategy helps businesses to avoid rolling the dice when they sell overseas, buy from foreign suppliers, or produce products outside of the U.S. It offers advantages including reducing uncertainty and providing protection against any unfavorable currency movements. This allows you to protect profit margins, and focus on your core business.
There are several options for hedging that can reduce or eliminate the foreign currency risk exposure to help businesses to navigate any periods of heightened volatility better:
Even if your business is not impacted by imports and exports, your bottom line could still be impacted by a weak dollar. If your expenses increase, you need to think about possible strategies you could use to counteract this trend. In many cases, this may be something as simple as having an emergency fund, but you may also need to plan possible pricing increases into your overall business plan.
Currency fluctuations can have a massive impact on consumers and businesses. Some businesses are more susceptible to currency movements, but since it has wider implications across the economy, it should be something that all businesses consider.
As a business owner, you’re likely to be aware of the importance of being flexible, but you may want to add some contingencies into your business plans. This will allow you a margin to cover any increased running costs that may occur as a result of the dollar dropping in value.