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Market Preview: Exchange Rate Shifts Leave a Mark

by 5m Editor
26 May 2007, at 8:42am

US - Weekly US Market Preview w/e 25th May, provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.

The importance of exchange rates in matters of international trade has been noted in this column on several occasions. While the supply and demand for a commodity are the primary determinants of price within a country, exchange rates are the method for translating that price into a value from one country to the next. No discussion of trade is complete without at least considering the impacts of exchange rates.

There are a few basics to keep in mind. First, if you are an exporter, you are always better off to have a cheap currency because it makes your goods less expensive to foreign buyers. Another way to look at it is that foreign currencies have more buying power when an exporter's currency is low. So, strengthening currencies in customer countries is a good thing.

Second, the same relationship applies to the currencies of countries with whom you compete in the export market. If your currency is lower-valued, your goods are less expensive to importers.

Third, it is not necessarily the level of the exchange rate, but how the rate is changing. A steady exchange rate allows the countries' separate economies to adjust, but a changing exchange rate will cause constant changes in competitive position. When exchange rates fluctuate, these gains in competitive position ebb and flow. But when exchange rates follow one trend for long periods of time, the competitive position effects are one-sided and can eventually be very detrimental to countries on the unfavorable side of the trend.

Figure 1 shows the exchange rates of three major competitors to the United States in international pork markets. Note that the construction of this graph in units/U.S. dollar ($US) means that the slopes of the lines indicate the change in the value of the U.S. dollar. A declining line means that the U.S. dollar is falling in value relative to the subject currency. It is obvious that these changes are favoring the United States.



Figure 2 shows the exchange rates of three major pork export customers of the United States. Korean customers are clearly gaining buying power relative to the U.S. dollar. That, in part, explains the terrific performance of U.S. exports to Korea in 2006. In addition, the currencies of Japan and Mexico have been relatively stable vs. the U.S. dollar, while the exporting countries' currencies in Figure 1 have gained value compared to the U.S. dollar in recent years. That means that those exporting countries were losing competitive position relative to the United States, even when the importers' rates vs. the U.S. dollar were more or less constant.



Then There's Canada

University of Missouri agricultural economist Ron Plain gave a great example at last week's Pork Management Conference sponsored by Pork Checkoff. I'll use Plain's basic idea as the basis for this next discussion.

Assume that a Canadian producer in early 1997 built a hog farm and signed a contract to deliver pigs to the United States for $100 ($US). At the time, the exchange rate was roughly $0.75 for each $1.00 in Canadian currency ($Can), meaning each pig generated about $134 ($Can).

By January 2002, the Canadian dollar had weakened to about $0.62 for each $1.00 ($Can). The Canadian producer's pigs still fetched $US100, according to the contract, but that now converts to over $160 ($Can). Not a bad deal since a good portion of the producers' costs (all fixed costs and labor) would still be denominated in $Can and have not risen as the Canadian dollar devalued. This was a tremendous incentive (among others) for the Canadian industry to grow.

But now consider what is happening to a production unit built by the same producer in 2002 with the intent to sell the same $100US pigs. First, it took far more of the less-valuable Canadian dollars to build the unit in 2002 than it did to build the one in 1997. Second, instead of bringing in $160 ($Can), the pigs coming out of this new unit are now generating only about $110 ($Can). While the stronger Canadian dollar makes some inputs (grain, medications) less expensive, since they are generally priced off the U.S. market, it makes those fixed costs and labor far more expensive. This illustrates the flip side of the effect of the cheaper Canadian dollar from the '90s into 2002.

Adding insult to injury, the "improvement" of 2006 that saw the Canadian dollar lose about 6% of its value vs. the U.S. dollar from June through February, has now been wiped out.

The weekly average for the week ending May 11 was $0.9054US/$Can. That is just shy of the highest ($0.9077) level in my data set that goes back to 1992. June Canadian dollar futures are trading this morning at $0.9266 -- a new record on the weekly chart.

None of this is news to Canadian producers, but U.S. producers need to clearly understand how exchange rates impact the world in which they work every day.



5m Editor