Exporting and Trading info

Case: Caterpillar and the Fluctuating Dollar Caterpillar, one of the world's largest heavy-equipment manufacturers, has been beset by two major problems: competition from Komatsu Ltd. of Japan and a fluctuating U.S. dollar. The 30 percent strengthening of the dollar against the yen in 1989 and early 1990, as noted in Fig. 8.2, made Japanese goods less expensive in the United States and third-country markets, giving Komatsu a substantial competitive advantage, and in early 1990, for the second time since 1981, Caterpillar executives tried to plot a strategy on how to cope with the strong dollar. Caterpillar concentrates in the worldwide production and sale of heavy equipment and engines. (See Map 8.2.) It manufactures products in wholly owned or affiliated plants In the United States, Brazil, Canada, France, the United Kingdom, Australia, Belgium, Indonesia, India, Italy, Japan, and Mexico. It also has contract manufacturers in the United States, Finland, Norway, South Korea, th...

Summary of The Determination of Exchange Rates ■ The International Monetary Fund (IMF) was organized in 1944 to promote exchange stability, maintain orderly exchange arrangements, avoid competitive currency devaluation, establish a multilateral system of payments, eliminate exchange restrictions, and create standby reserves. The Special Drawing Right (SDR) was instituted by the IMF to increase world liquidity. The currencies of countries that are members of the IMF are divided into three categories: those that are pegged (fixed in value) to a single currency or to a composite of currencies, those that have displayed limited flexibility compared with either a single currency or a group of currencies, and those that are more flexible. Many countries that strictly control and regulate the convertibility of their currencies have a parallel, or black, market that maintains an exchange rate more indicative of supply and demand than is the official rate. The Bank for International ...

BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES Market Decisions On the marketing side, exchange rates can affect demand for a company's products at home and abroad. A country such as Mexico may force down the value of its currency if its exports become too expensive owing to relatively high inflation. Even though inflation would cause the peso value of the Mex- ican products to rise, the devaluation means that it takes less foreign currency to buy the pesos, thus allowing the Mexican products to remain competitive. One interesting ramification of a peso depreciation is the impact of the cheaper Mexican goods on exporters from other countries. For example, the cheaper Mexican goods flooding the market in Argentina might take away market share from Italian exporters, thus affecting the Italian economy. A good example of the marketing impact of exchange rate changes is the problem that Japanese car manufacturers were having selling to the United States in 1986 and 1987 due to...

Types of Transactions Current Account T he current-account balance is very important because it summarizes the real transactions that occur in a country. The current-account balance includes merchandise trade; other goods, services, and income; and unrequited transfers. The merchandise trade balance is critical because of the sheer volume of transactions that takes place. The export of merchandise is a credit because it results in the receipt of payment from abroad. An import is a debit because it results in making payment to the seller abroad. The balance of trade is important, because it is the most basic measure of a country's transactions with the rest of the world. Even though the U.S. has a large balance-of-trade deficit, it has been improving steadily since 1986. A merchandise import or export involves an exchange where a buyer in one country and a seller in another country exchange something of equal value. However, an unrequited transfer (or unilateral transfer) occu...

The Balance of Payments A country's balance of payments summarizes international transactions between domestic and foreign residents. A more comprehensive definition follows: The balance of payments is a statistical statement for a given period showing (a) transactions in goods, services, and income between an economy and the rest of the world; (b) changes of ownership and other changes in the economy's monetary gold, special drawing rights, and claims on and liabilities to the rest of the world; and (c) unrequited transfers and counterpart entries that are needed to balance, in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting." The concept of double-entry accounting holds true in the balance of payments. This implies that each transaction has two entries of equal value that must be accounted for. Debit entries have a negative arithmetic sign, and credit entries have a positive arithmetic sign. The debit en...

FORECASTING EXCHANGE-RATE MOVEMENTS In the previous section we looked at the general law of supply and demand, showed how governments intervene to manage exchange-rate movements, and explained how inflation and interest rates can be important determinants of exchange rates. In this section we survey data that can be monitored in order to get an idea of what will happen to exchange-rate values. As the preceding discussion elaborates, a variety of factors influence exchange-rate movements. Managers must be able to analyze these factors in order to have a general idea of the timing, size, and direction of an exchange-rate movement. However, prediction is not a precise science, and many things can cause the best of predictions to differ significantly from reality. For freely floating currencies, the law of supply and demand determines market value. However, very few currencies in the world are freely floating; most are managed to a certain extent, which implies that governments need t...

Other Factors A variety of other factors could cause exchange rates to change. One important determinant in a world of political and economic uncertainty is that of  confidence. During times of turmoil, people prefer to hold currencies that are considered safe-haven currencies. During the early 1980s the U.S. dollar was considered a safe-haven currency, and this perception was an important source of its strength. In 1990, after Iraq invaded Kuwait, the dollar strengthened a little because of the safe-haven concept, but weaker economic fundamentals eventually forced the dollar down. When the Mexican peso began to slide in the early 1980s, local investors transferred large amounts of pesos out of Mexico via dollar transfers until the Mexican government clamped down. The investors had no confidence in the peso and preferred to hold dollar balances outside of Mexico. In addition to the basic economic forces and confidence in leadership, exchange rates are influenced by a number of ...

Purchasing-Power Parity Purchasing-power parity (PPP) is the key theory that explains the rela- tionships between currencies: In essence, it claims that a change in relative  inflation must result in a change in exchange rates in order to keep the prices of goods in two countries fairly similar. Figure 8.1 illustrates this point. Ac- cording to the PPP theory, if Japanese inflation, for example, were 3 percent and U.S. inflation were 6 percent, we would expect the value of the dollar to fall by the difference in the interest rates. That means that the dollar would be worth fewer yen than was the case before the adjustment, and the yen would be worth more dollars than before the adjustment. The PPP theory is very useful in explaining the relationship between exchange rates, but it is not perfect. We need to make assumptions about the equilibrium exchange rate at a starting point and recognize that currencies are rarely related accurately in a two-country world. When seve...

Major Types of Exchange Systems As noted earlier, exchange rates are either freely floating or fixed to something. The following sections explain how rates change under three major types of exchange-rate systems: freely fluctuating, managed fixed, and automatic fixed. In addition, the roles of purchasing-power parity, the Fisher Effect, and other factors related to the relationships between currencies are discussed. Freely Fluctuating To understand the law of supply and demand as it relates to foreign exchange, we will use a two-country model involving the United States and Japan. Figure 8.1 illustrates the concept of equilibrium in the market and then a movement to a new equilibrium level as situations change. The demand for yen in this example is a function of U.S. demand for: (1) Japanese goods and services and (2) yen-denominated financial assets. An example of the former would be the U.S. demand for yen to buy Japanese-made autos. An example of the latter would be U.S. deman...

The Role of Central Banks Each country has a central bank responsible for the policies that affect the value of its currency on world markets. The central bank in the United States is actually the Federal Reserve System (the Fed), a system of twelve banks, each representing a region of the United States. The New York Federal Reserve Bank handles the system's intervention in the foreign-exchange markets. Intervention policies are determined by the Federal Open Market Committee. However, the Fed does not act independently of the rest of government; in particular, the Secretary of the Treasury is legally responsible for stabilizing the exchange value of the dollar.7 In spite of the unique nature of the central bank system in each country there is some semblance of international cooperation through the Bank for International Settlement (BIS) in Basel, Switzerland. One of the functions of the BIS is to act as a central banker's bank. It gets involved in swaps and other currency ...

Exchange-Rate Arrangements The Jamaica Agreement formalized the break from fixed exchange rates. As part of this move, the IMF permitted countries to select and maintain an exchange arrangement of their choice, as long as they properly communicated their arrangement to the IMF. Each year the IMF receives information from the member countries and classifies each country into one of three broad categories: 1. currencies that are pegged to a single currency or to a composite of currencies; 2. currencies whose exchange rates have displayed limited flexibility compared with either a single currency or group of currencies; and 3. currencies whose exchange rates are more flexible.3 Table 8.2 identifies the countries that fit in each category. Note that the countries in each category are subject to change each year. In 1983, for example, there were 38 countries pegged to the U.S. dollar, compared with only 31 in 1985 and 28 by mid-1990; there were 33 countries in the more-flexible categ...

The International Monetary Fund The Depression, economic isolation, and trade wars of the 1930s were followed by the global conflict of World War II. Toward the close of World War II in 1944, the major Western governments met to determine what international institutions were needed to bring relative economic stability and growth to the free world. As a result of the meetings, the International Monetary Fund (IMF) and World Bank were organized. The IMF was signed into existence in the United States in 1945 by 29 nations; the agreement now includes 151 countries. The IMF's major objectives are to promote exchange stability, maintain orderly exchange arrangements, avoid competitive currency devaluation, establish a multilateral system of payments, eliminate exchange restrictions, and create standby reserves. The Bretton Woods system, named after the location of the 1944 conference, operated under a principle of fixed exchange rates by which each member country established a par v...

Case: The Japanese yen "The currency of Japan is the Japanese yen. The authorities of Japan do not maintain margins in respect of exchange transactions, and exchange rates are determined on the basis of underlying demand and supply conditions in the exchange markets. However, the authorities intervene when necessary in order to counter disorderly conditions in the markets. The principal intervention currency is the U.S. dollar. . . . Authorized banks may freely carry out spot and forward exchange transactions with their customers, nonresident banks, and among themselves. Forward exchange contracts may be negotiated against foreign currencies quoted on the Tokyo exchange market and in other major international foreign-exchange markets. There are no officially set rates in the forward market, and forward exchange transactions are based on free-market rates. There are no taxes or subsidies on purchases or sales of foreign exchange." Thus the yen is very different from the pe...