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Currency risks not major business concern

By SHIHOKO GOTO, UPI Senior Business Correspondent   |   June 17, 2004 at 3:46 PM
WASHINGTON, June 17 (UPI) -- There's a growing division in Britain between those who want the country to be a more integral part of Europe by abandoning the pound sterling in favor of the euro, and those who object to that idea. For opponents of the pan-European currency, it's as much a politically emotional issue as an economic one, as forfeiting the pound is regarded as paramount to giving up sovereignty. But for those calling for Britain to join the euro zone, they argue that the country's economy would suffer in the long run unless it joins the group.

Proponents of the euro in Britain have claimed that the country will lose out on foreign investments should it continue to reject the prospect of joining the euro zone, as companies from the United States and Japan in particular will want to be on the European continent to avoid foreign exchange fluctuations and risks. For instance, they argue that foreign investors would want to set up offices and production lines in Germany or France, where they will be able to trade within the euro zone without being exposed to currency risks.

But that logic doesn't necessarily follow through.

"There is no overwhelming evidence" to support such claims, said former Federal Reserve chairman Paul Volcker Thursday. Volcker, who was the head of the central bank from 1979 to 1987, briefing reporters on the latest findings in foreign exchange rate mechanisms compiled by the Conference Board, a New York-based economic research group. He is currently chairman of the Group of 30, an international financial group which worked with the Conference Board on the report.

"We hear anecdotally that businesses choose one or another country to locate a plant or facility because of exchange rate considerations, but it is hard to identify the magnitude and breadth of these decisions or measure their economic impact," he added.

In its global survey of corporate leaders on exchange rates, the Conference Board found that of the 400 executives who took part in the study from 38 countries, 60 percent said foreign exchange rates were only "somewhat important" in their investment decisions. In industrialized countries in particular, chief executives and financial officers were more concerned about political risks and a country's legal environment.

Only 20 percent of those surveyed ranked currency fluctuations as "very important" to their investment decisions, the research group found.

"Many of the traditional methods of coping (with currency risks), like financial hedging and or adjusting prices for exchange rate changes, have significant costs and are undoubtedly a management headache but do not seem to shape the global presence, even of emerging market companies, in a major way," said Marina Whitman, a professor of business administration at the University of Michigan.

So companies continue to be attracted to Britain at their European foothold for its favorable business environment that can outweigh the risks of exposing investments to currency fluctuations, most notably between the pound and the euro.

At the same time, it is clear that companies are less bound by nationalistic pride to do business in their own currency. Instead, the Conference Board found that companies are increasingly doing business in either the U.S. dollar, in the case of Asian corporations, or the euro, in Latin America's case.

"I asked a Canadian whether they'd adopt the U.S. dollar" and simply abandon the Canadian currency, Volcker recounted. "He said 'I don't care what the currency is. I just run the business as if (the U.S. dollar) is (the national currency.'"

Indeed, over 50 percent of non-U.S. companies surveyed use the greenback in pricing and sourcing, while 25 percent of non-euro zone companies use the euro.

"Businesses, not countries, make trade decisions, and they do not appear to feel bound by their home country currency," said Gail Fosler, chief economist of the Conference Board.

"These results are supported by the growth in foreign currency deposits in the global commercial banking system," Fosler added.

The attractiveness of the dollar and the euro for the international business may actually be a key factor for allowing the United States or indeed the euro zone to have a trade deficit whilst having a strong currency at the same time. In the case of the United States, having the greenback as the de facto currency of international trade, combined with the fact that many Asian nations in particular have built up their currency reserves in the U.S. dollar, is keeping the trade deficit sustainable, the Conference Board said.

"The tendency of a currency like the U.S. dollar to strengthen when trade deficits were rising, as was the case during the late 1990s, may be partly the result of this incremental transactions demand for dollars. Similarly, as the use of the euro in international transactions widens, the EU may find that it is difficult to impact its trade accounts through currency exchanges," the research group stated.

If that were indeed the case, then the rise or fall in the value of the dollar would only have a limited effect on the U.S. trade deficit.

"To the extent that the U.S. dollar becomes the preferred global currency for international transactions, changes in the value of the dollar will have little direct effect on prices...this result calls into question the conventional wisdom that a decline in the dollar is the solution to the U.S. trade deficit or that the revaluation of another currency like the Chinese (yuan) will have real effects," argued Fosler.

Topics: Paul Volcker
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