When the Dollar Rises, Who Will Become the Enron of Foreign Exchange?

The Decline of the Dollar—Then and Now

When it comes to foreign exchange, the more things change, the more they remain the same. Today, the dollar is weakening dramatically.  Volatility is high.  European and Asian companies are struggling to manage the negative impacts of the strength of their currencies compared to USD.  Meanwhile, Europeans vacationers are coming in hordes to cash in on their newfound buying power. U.S. interest rates are easing. Gold is trading around $800. The British Pound is trading above 2.05 to the USD. US firms are asking themselves whether they should be hedging.  Regulatory bodies are talking about changing disclosure requirements.  All of these things are as true today as they were back in 1980!

Of course, after 1980, things changed. The dollar regained its strength and companies on both sides of the Atlantic (and the Pacific) were forced to react to new market realities. Many stakeholders who took their eyes off the fundamentals in the late 1970s were unprepared for changes in the early 80s that led to serious economic consequences. Then, as today, the dollar’s weakness had obscured some underlying problems.

The Shape of Things to Come?

Looking at economic history in terms of seven-year cycles, we can examine the events after the rebound of the dollar in 1980 for signs of things to come in 2008, just four cycles later. In 1980, economic impacts drove regulatory bodies to do what they always do after a crisis in confidence: increase scrutiny on stakeholders.  This led to the introduction of FAS 52 in 1981 and increased disclosure requirements.  If current trends follow suit, a rise in the dollar will be marked by economic losses and financial restatements by U.S. multinationals, followed by another round of regulations and stakeholder scrutiny.

There are many recent examples of industry-leading, European and Asian multinational companies that have suffered material losses due to the strength of their currencies relative to the U.S. dollar—SAP, Reuters, Lufthansa, and Cannon, among them.  FX-related corporate losses for U.S. multinationals will be triggered by a sharp – even if not sustained – dollar strengthening. Some of these companies will face serious consequences, revealing themselves as the “Enrons of FX”.  The dollar’s turn-around will trigger sudden, unexpected financial results that will have a domino effect on corporate value.  Economic surprises will lead to further scrutiny by stakeholders. This will trigger compliance questions with dramatic negative impacts like those experienced by Allied Defense.

Today, European and Asian companies have been forced to ask themselves, “How do we more accurately identify and quantify currency exposures?” and “How do we communicate this to stakeholders, so they are not surprised?”

Better Data and Automated Processes Lead to Predictable Results

All companies that generate revenue or incur costs in foreign currencies can suffer from foreign exchange volatility. But for companies with inadequate or non-existent exposure management policies, the fallout can seriously impact the bottom line, jeopardizing share prices for public entities, or the prospect of a successful IPO for start-ups.

From one perspective, the risk of currency fluctuations is one of the easier financial risks to manage. Exchange-traded options, currency swaps or forward contracts can all lock in exchange rates to protect cash flows from the effects of currency swings. But before these kinds of hedging strategies can help, companies need to understand and accurately quantify their exposure so they know where—and why— they are vulnerable.

The Chief Finance Officer who seeks greater involvement in the definition of currency risk management policies, and endorses a holistic, collaborative approach to the problem can set his or her organization on the right path to getting their accounting and compliance right, so they can focus on optimal economic decisions. The automation of these processes increases efficiency, reduces errors and supports the kind of cross-functional collaboration needed to ensure that foreign exchange exposure management becomes a economic strategy, rather than an unanticipated consequence of uncoordinated activities.