Week 9: Best Practices 8

Ch8 Foreign Economic Cycles

Chapter Opening Questions

A manager needs to:

• Needs to watch the federal reserve policy in both the US and around the world

Summary

For a major industrialized country, the monitoring system would closely resemble that used in the United States with an addition of foreign exchange risk.

For a less developed country,

Risk	Indicators
monetary policy	varies depending on individual countries
foreign exchange risk	divergence between PPP and actual exchange rate
capital control	country’s bond credit ratings and stock exchange prices
oil	know how dependent the country is on imported oil
commodity	commodity price
trading partner risk	know who the major trading partners are (including tourism)
war or rebellion	local press

Monetary policy around the world

• In many countries policy is determined by the treasury officials. Their main goal is to keep interest rates low while also stimulating the economy. Monetary policy is a major cause of business cycles. In small less developed countries trading partners, major trading ports, and political crisis. you must ask yourself how separate is the central bank from the government/administration. The less independent the central bank the less stable the swings of money will be.

Supply shocks in foreign countries

• The severity of the supply shock depends on the countries dependency on that product. Countries that have a greater dependence on foreign oil have a greater response to supply shocks thank countries with some oil, like the United States. Although the small domestic oil supply doesn’t protect the US from an oil price hike.

Commodity risk in small countries

• Small countries often mass produce a single product or good making them at substantial risk of swing in the price of the product. The volatility of those countries is greater than those with diversified economies. Mineral products are usually more stable in supply than in demand. Agricultural products demand stays relatively stable while supply varies wildly. Technology can also change product demand around the world. If your selling products to a country dependent on them you must determine how important that product is to the country. Commodity prices will bounce back over time and workers will shift over to more relative sectors.

Trading partner risk

• Small countries are at major risk with trading partners. Trading partners with smaller countries are most often typically nearby and larger economies. You must asses your counties major export partners in order to know the risk.

Foreign exchange risk

• Exchange rates of currencies can differ between countries and often fluctuate. Often times differences in exchange rates affect overseas companies. Exchange rates can raise, lower or even eliminate profits. If a countries currency declines in value the payments they make to their overseas operations may not cover the operation costs.

Financial crisis in foreign countries

• Foreign exchange controls can prevent movement of profits from a foreign country. A financial crisis occurs when a country has no exchange reserves or credit that’s needed to meet international needs. These financial crisis often lead to a recession in the foreign country. This clobbers a countries ability for it’s consumers to buy goods and services.

War and Revolution

• Wars are not good for countries and even their traders. Often the problem occurs when countries are no longer able to trade due to blocked imports or conflicts. Businesses operating in a less-stable country they have to consider how closely its fortunes are tied to the ruling regime. Revolution and war must be considered red flags to business managers.

Managing through the foreign business cycle

• Different businesses overseas may have different profits and activity. If your company is primarily manufacturing goods overseas other problems occur. Managing staff levels in an overseas operation can be tricky and sometimes may not even be adjusted. Buyers from American industries must be cautious and get to know their oversea;s vendors. Eve if the company doesn’t go bankrupt they might lack the capital to continue going.

The monitoring system

• First step is to watch the United States Monetary Policy. In foreign countries that don’t follow a system similar to the United States other factors must be watched. Short-term and long-term interest rates are also a good indicator for the country current financial situation. Oil supply shocks can also be monitored with the assumption that they are more or less oil dependent that the United States. Examining the countries export destinations and their potential trade risks.

Contingency plans

• Foreign exchange crisis can limit capital put of a foreign country. These risks can be mitigated by keeping capital lean with the foreign country. Even during a downturn reassuring employees that they will keep their jobs is good but that they will not be hiring after the commodity boom is over. A company’s first concern should be the safety of its employees. During this time families will be hoarding their liquid assets and businesses will be uncertain about future capital expansion projects.

Summing Up

• Economics fluctuations are more varied in certain foreign countries. Doing business with foreign countries can be quite profitable, but doesn’t come without the risks.

Economic terms

Explain each of the following terms in your own words. The author explains the terms in the textbook. If necessary, you may also Google the term on the Web. Good resources include:

• The Economist
• Fun economic videos

Explain the terms in your own words briefly.

Foreign Exchange Rate (page 180)

• Is the rate when one countries currency will be exchanged for another currency and affects trade and the movement of money between countries.

Pegged Exchange Rate (page 180)

• When the national government sets a specific exchange rate for it’s currency and other curries that are used in trading currency.

Floating Exchange Rate (page 183)

• When a nation’s currency is set by the forex market through supply and demand.

Currency Devaluation (page 183)

• When a government makes a monetary policy change to reduce the value of their money.

Currency Depreciation

• When a nation’s currency value falls versus other countries currencies.

Foreign Exchange Control (page 183)

• When restrictions are applied by governments to ban or stop the sale of foreign currencies in that nation or country.

Purchasing Power Parity (page 192)

• The rate of one nations currency converted into another countries currency to buy the same amount products or service.

Economic events

Describe the characteristics of the following events briefly.

“el error de diciembre”, the Mexican peso crisis of 1994 (page 183)

• In 1994 Mexico placed three pesos at the value of per greenback. The Mexican president let the peso’s value sink. It fell from 1/3 of the dollar to about 1/10 the value of the dollar. The peso’s earning could not be translated to American Dollars and the US was losing money.

The Indonesian financial crisis of 1998 (page 184)

• Indonesia’s manufacturing sector relied on bank credit in order to finance their operations. They began to borrow from international banks owing dollars. The devaluation of the rupiah prevented large manufacturing facilities from repaying the loans in American dollars which were valued higher.

The Asian financial crisis of 1997-1998 (page 189)

• Many companies went into bankrupcy because they were not able to repay their American-dollar loans. They were able to convert raw goods into finalized materials at reasonable profit margin, but only due to the fact that their currency had fallen relative to the American dollar.