When the U.S. debt rating was downgraded recently by Standard & Poor’s, Kirk Demeter’s already-shaky faith in the dollar fell further. He sprang into action.
Mr. Demeter took advantage of concerns about a global growth slowdown and a second U.S. recession to lock in the Australian dollar in his largest-ever foreign-exchange transaction. Believing the Australian dollar wouldn’t stay down versus the U.S. dollar for long, he purchased currency options allowing him to buy the Australian dollar later at hoped-for bargain prices.
Who is Mr. Demeter? A professional currency trader? A Wall Street trader?
Mr. Demeter isn’t a professional currency trader. He owns a vacation-travel company, Down Under Answers, in Bellevue, Wash., that specializes in package deals to Australia and New Zealand.
The company agrees to a travel-package price with a U.S. customer, but it purchases hotel bookings, airfare and tours at a future date. If the Australian dollar takes off against the U.S. dollar in the interim, the difference comes out of Mr. Demeter’s pocket.
One of the problems with a floating exchange rate is that it introduces a new variable for businesses to consider. It makes business more complicated than it need be. How much time does Mr. Demeter spend on the issue of exchange rates? What happens if he’s wrong about the direction of the Aussie Dollar? How can he plan for the future when his profit margin can fluctuate wildly from month to month based on nothing more than his ability to guess the future value of the dollar?
It isn’t just businesses such as this one with direct exposure to the exchange rate that are affected. Volatile exchange rates also make commodity prices, interest rates and a host of other variables more volatile as well. Almost every business is affected whether they are aware of the cause or not. The falling dollar over the last decade has no doubt distorted investment in natural resources as commodity prices have risen. Investments that make sense with oil at $100/barrel may make no sense at all with oil at $50/barrel. When the dollar reverses course, as it did in 2008, plans made based on higher commodity prices are suddenly revealed as uneconomic. Those who hedge improperly can be wiped out regardless of the health of their underlying business. A number of businesses – airlines come to mind – reported large hedging losses in 2007 and 2008 due to not being properly hedged. Even companies that do hedge properly must tie up capital in the hedge transactions that could be better utilized in their underlying business.
The era of floating exchange rates needs to end. Travel agents should not have to devote part of their precious capital to protecting their profit margins from the whims of Ben Bernanke. A strong and stable dollar – we at Alhambra prefer a return to the gold standard – would allow Mr. Demeter to concentrate on selling vacation packages rather than speculating on the value of the dollar.