In her August 2015 Wall Street Journal article “China Economic Upheaval Mints Winners and Losers,” author Laurie Burkitt fails to mention one key winner: Those companies that outsource elements of their supply chain to China. They win because currency exchange rates continue to favor savvy USD buyers.
The statistics about China’s recent explosive economic boom — and subsequent slowdown of growth — were both helpful and eye-opening. That is, many knew China’s economic growth was strong, but many may not have realized exactly how strong.
Throughout the last decade infrastructure companies from all over the world rushed to meet China’s demand which helped spur further growth, peaking in 2011. Since then double-digit growth continued but the numbers have inevitably shrunk.
The Back-Story to China’s Growth
What makes this topic timely is the huge volatility in China’s stock market, which has several proximal causes. While the economic statistics sited in the article aren’t new (they have been closely tracked through the last eighteen months), in retrospect, China’s stock market bubble should have been obvious. But the huge economic declines have been a big surprise and a cause for legitimate concern. What does it mean? Not just for US companies working on infrastructure projects in China, but for the developing economics of the Chinese people. Will they, like the article suggests, continue to be largely unaffected? Personally, I doubt it.
Historically, the stock market is not an isolated factor and, unlike consumer sentiment, it is a leading indicator. The article sounded a lot like the articles written in the wake of the 1987 crash. Those interviewed didn’t feel any different than the week before the sell-off, which is understandable.
Today, consumers continue to spend and the retail sector is strong. That’s exactly what people said in 1987. The reasoning was something like, “Stocks are not as widely owned as they were before the 1929 crash and the subsequent Great Depression.” But that didn’t seem to matter then because the drop in the stock market was a signal of a severe economic pullback that, one way or another, affected every single person. I suggest that the same is true in the case of China’s upheaval.
So, who are the real winners?
As noted previously, the real winners were omitted from Burkitt’s article: Savvy US companies doing business with China’s suppliers. Not every company working with China in its supply chain, however, will benefit, because the determining factor is currency exposure.
Companies purchasing China-made products and services in USD have “managed” currency risk by passing it along to their Chinese suppliers. In that case, the suppliers will be beneficiaries of any weakening in their currency. Those suppliers will convert revenue received in dollars to more yuan than last year, with more profit left over after paying employees in yuan. In contrast, companies that negotiated lower prices because they retained currency exposure instead of passing it along may be poised to benefit from the strengthening dollar.
Managing Currency Risk
The key take-away is not whether a company chooses to bet on currency exchange rates. Instead, the important questions are:
- What is my firm’s currency exposure?
- How do we measure (quantify) it and what is my company’s tolerance?
- What is the best way to manage it?
- How do we communicate this to our board and other stakeholders?
By spending time to research and answer these questions, an organization can develop a consistent framework for managing its currency risk.
While there are multiple approaches that can be used to achieve this goal, Grayline’s Six-Factor Framework has been successfully deployed with a number of businesses to help them manage currency risk.