Riding with the currency: when the dollar loses value in the world markets, there are pitfalls to watch out for. Here's how to benefit whether it is weak or strong

Black Enterprise, Dec, 2004 by Rene Brinkley

Harlan Brandon knows shoes. After 15 years of designing them for companies such as Nautica and Fila, the 50-year-old New York City native stepped out on his own two years ago and launched HBF Collection, his premier line of shoes. But his extensive knowledge of shoes was not enough to ward off a threat to his budding business. The designer-turned-entrepreneur would soon get a crash course in currency valuations.

His introductory line of shoes was manufactured in Italy, then imported to the U.S. so that major department stores could review his designs. The shoes are priced between $90 and $110, but soon after opening shop, Brandon realized he wouldn't be able to turn a profit. "When I started out, I was just making it," Brandon explains, "then the euro got stronger and stronger.... I just couldn't continue."

During Brandon's first year, the dollar weakened progressively against the euro, and a weakening dollar buys less units of a foreign currency. In August 2002, when Brandon began purchasing Italian components, it cost 98 cents to buy one euro. By August 2003, it cost $1.16. Brandon saw his costs increase by 18 cents, and his profit margin virtually disappeared. Instead of raising the price of his shoes, Brandon moved manufacturing to India, where the dollar is still strong. His experience is one example of how currency fluctuations and a weak dollar can directly impact business owners. When the dollar is weak business owners face higher costs, which potentially trickle down to consumers in the form of higher prices.

WHAT DRIVERS THE COST OF MONEY?

The pricing of money occurs on the foreign exchange market, also known as forex. It is the largest financial market in the world. More than $1 trillion is traded daily--U.S. dollars for euros, euros for yen, etc. Just as the value of a U.S. company is set by the U.S. stock market, a country's currency, when left to free market dynamics, is determined by forex.

During the last two years of the Bush administration, the U.S. dollar has plunged in value against the world's major foreign currencies, more than 22% since early 2002. Some experts point to the increasing federal deficit as a primary reason. The Congressional Budget Office projects the deficit will hit $422 billion this year. According to Joseph Davis, an investment analyst and economist with the Vanguard Group, two factors have played a key role. One is the record-low, short-term interest rates, which have recently begun to rise through the actions of the Federal Reserve. The other is that the U.S. trade-deficit-to-GDP ratio is roughly 5%, a level many economists say is unsustainable.

WHEN THE DOLLAR IS WEAK

A weak dollar not only affects business owners with international operations like Brandon, it also influences whether Americans can afford a trip overseas and how much they spend in a foreign country. Pete Anderson, for example, a 36-year-old newlywed, understood how a weak dollar could affect his honeymoon with wife Lisa. While traveling to Indonesia several years earlier as part of an M.B.A. program, he became keenly aware of the effect currency values had on his wallet.

"When I was in Jakarta in 1999, they were in the midst of their currency crisis. So the rupiah [Indonesian currency] was cheap to buy. As a tourist, I could buy almost anything I wanted. I could live like a king," Anderson says. For example, he stayed at a five-star hotel for $45 a night, hired a chauffeur several times during his stay at $15 per day, and purchased a custom-made suit for about $400. "So when I began thinking about going to Europe for my honeymoon, I didn't want the reverse to happen to me," Anderson says. "I didn't want the euro to suck me dry."

When Anderson began researching his trip in the summer of 2002, the dollar had been on a steady decline against the euro. In May 2002, investors paid 89 cents per euro. Three months later, one euro costs $1.02--a 12% drop. Anderson, who pays close attention to the news and economic reports, became concerned about exceeding his budget and took action. "I said, wait a minute. If I have a $5,000 budget and the dollar drops another 10% against the euro, that's an extra $500 it'll cost me. So I wanted to lock in my costs as soon as [I] could."

In February 2003, six months before his trip, Anderson paid for hotels, car rentals, and travel packages. By that time, the dollar bad fallen an additional 4.9%. Anderson was wise to buy sooner versus later. Given the rapid rate of the dollar's decline, what would have cost $89 in May 2002 would have been $119 by June 2003. By purchasing early, he saved more than 34% on the cost of the trip.

But a weak dollar isn't bad news for everyone. It's a boost to American industries since it makes American products cheaper abroad. This increases demand for those products and can potentially lower the trade deficit. It can also mean strong returns for U.S. investors with international assets. According to Morningstar, the one-year average return for international stock funds for the week ending Sept. 10, 2004, was 17.85% compared to an average return of 11% for domestic stock funds.