FX International Payments
By Karen Lynch
Analysts and policymakers generally agreed with recent projections from the Organization for Economic Co-operation and Development that the rise in inflation would be gradual.7 For the purposes of this article, the question is not whether, how much, or when, but how import-export companies might manage whatever inflationary pressures could be coming their way.
Rising inflation means that a dollar can buy less over time, which challenges nearly every aspect of a business, from consumer demand and the cost of such inputs as raw materials, labor, and money – to inventory management, capital investment planning, and the pricing of outputs in goods and services.
An academic paper from the 1970s, when the U.S. labored under double-digit inflation, described the conditions businesses faced at the time: "Under inflation the purchasing and employment managers … find that, economize though they may, more and more money is required to buy the same amount of goods and services, including labor. The pricing manager also must be quick on his feet to avoid a cost-price squeeze; hence he must seek to keep his prices ahead of costs as far as competition and other factors allow."8 The financial manager, meantime, is pressed to expedite the collection of accounts payable and put liquid assets to work as fast as possible, the paper observed.
Factors such as differing rates of inflation from country to country mean that inflationary pressures can be particularly hard to manage at the international level. Central banks around the world have been trying for years to reset inflation to a more historically normal level (generally 2 percent), to stave off deflation. If they do, "it will be mostly good news for the world economy … so long as the moves don't go too far," according to New York Times columnist Neil Irwin.9
The central banks' efforts are having mixed results. In the U.S., the Fed's Survey of Professional Forecasters reported a May 2018 consensus on rising inflation in the Consumer Price Index – to an average of 2.5 percent this year, up from the 2.1 percent consensus of the previous quarter.10 Across the world, though, "while the U.S. had strong figures, Japan and the U.K. reported weaker headline inflation in March, and Germany and Italy saw headline inflation decelerate in April," as Megan Greene, global chief economist at Manulife Asset Management, wrote in the Financial Times.11
The effects of inflation on foreign exchange are the subject of some debate, and one generally agreed-upon theory is that rising domestic inflation weakens the relative value of a currency vis-à-vis other countries. However, additional factors can come into play. Central banks, such as the Fed, raise interest rates to throttle back inflation – by making it more expensive to borrow and spend.12 Higher interest rates can appreciate exchange rates.13
Meanwhile, the modern forces at work – such as global value chains,14 digitization,15 and e-commerce – are said to cast new light on established inflation theories, adding to the uncertainty of forecasts. Economists such as Steve Reed, at the Bureau of Labor Statistics, study how the so-called "Amazon effect" of lower online prices might be keeping a lid on inflation – even more so than the "Wal-Mart effect" that the bureau's research identified in the early 2000s, in which big-box discounters suppressed food prices.16
What's more, as was reported during the so-called "Great Inflation" of the 1970s, "inflation is notoriously uneven, with some prices advancing rapidly, some moderately, and some lagging behind."17 All of which means that businesses can end up with multiple, multidimensional, unpredictable issues that threaten their profit margins – rising inflation (at variable rates), rising interest rates, and shifting currency risks, among them.
The human element can be a powerful factor in responding to rising inflation. Businesses and consumers, alike, might be tempted to time purchases to avoid the effects of inflation. For example, a business could accelerate forward buying, weighing potential purchasing price advantages against the mounting cost disadvantages of holding inventory.18 In another scenario, retailers might benefit in the short term, as CNBC recently reported, if rising inflation catalyzes consumers to spend sooner to pay lower prices.19
Domestically, rising inflation makes local goods more expensive and less attractive to customers at home, who increasingly turn to cheaper imports. These higher prices can also reduce exports because of competition in international trade. Defensive approaches to export pricing can include positioning a product as an exclusive or premium brand, changing defined market segments, launching new products, or even exiting the foreign market, according to the BlackCurve pricing software company.20
In international supply chains, purchases of raw materials and components in foreign currencies are also subject to inflationary pressures. The cost of foreign raw materials and components increases as the purchasing power of the dollar falls relative to other currencies.21 "While most companies dependent on imported materials protect themselves from fluctuations through currency hedging, these hedges typically last 12 to 18 months at most," according to the Rathbones investment management firm. "So, while they give companies time to plan, they only delay the inevitable cost impact."22
Inflation can undermine supply-chain agreements, according to the EY global professional services firm.23 "Marmitegate" was a recent high-profile example of this in the U.K. Inflationary pressures in the supply chain were hotly debated in the media between the supplier of Marmite and a retailer of this British spread, with unpopular consumer price increases hanging in the balance.24
Words of supply-chain advice from the Harvard Business Review include this: "Beware of powerful distributors paying you more slowly than they turn the inventory they buy from you. In an inflationary environment, they're making money on the float by stretching their payables."25
Looking at inflationary pressures outside the U.S., BlackCurve notes the importance of managing supply costs from countries that have high inflation rates. Approaches to cost control can include modifying components or packaging materials, finding new low-cost suppliers of raw materials, shortening credit terms, quoting prices in stable currencies, and pursuing rapid inventory turnovers.26
Management consultants such as the Boston Consulting Group advise companies to be "inflation-ready," plotting product or business line exposures to rising inflation, determining the potential impact on profits and expenditures, analyzing organizational agility to respond, and formulating an "inflation protection plan."27
Ultimately, the extent to which companies can share the pain of inflation across their suppliers and customers will depend on three things, according to Rathbones: "the strength of their competitive advantage, their bargaining power relative to their supplier base, and their corporate strategy (and the extent to which pricing is a key element of it)."28
With expectations for moderately rising inflation on the U.S. horizon,29 and uncertainty about whether economic shocks could drive it higher, U.S. companies conducting international trade face pressures as their dollars buy less over time. The international trade implications can be mitigated through monitoring and planning for the effects of inflation.
Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.
1. “April 2018 Manufacturing ISM Report on Business,” Institute for Supply Chain Management; https://www.instituteforsupplymanagement.org/about/MediaRoom/newsreleasedetail.cfm?ItemNumber=31053
2. “All Prices,” oilprice.com; https://oilprice.com/oil-price-charts/block/1
3. “Employment Cost Index Summary,” U.S. Bureau of Labor Statistics; https://www.bls.gov/news.release/eci.nr0.htm
4. “Survey of Consumer Expectations,” Federal Reserve Bank of New York; https://www.newyorkfed.org/microeconomics/sce?mod=article_inline
5. “Pepsi, Hershey, UPS, and Other Earnings Reports Hint that Inflation Pressure is Mounting,” MarketWatch; https://www.marketwatch.com/story/inflation-is-starting-to-show-up-in-earnings-2018-04-26
6. “Is Your Portfolio Fit for the Future or Fashioned on the Past?” EY; http://www.ey.com/Publication/vwLUAssets/ey-ccb-18-edition/$File/ey-ccb-18-edition.pdf
7. “Interim Projections (March 2018),” Organization for Economic Co-operation and Development; http://www.oecd.org/eco/outlook/economic-outlook/
8. “The Impact of Inflation on Management Decisions,” Foundation for Economic Education; https://fee.org/articles/the-impact-of-inflation-on-management-decisions/
9. “The Era of Very Low Inflation and Interest Rates May be Near an End,” New York Times; https://www.nytimes.com/2018/04/26/upshot/the-era-of-very-low-inflation-and-interest-rates-may-be-near-an-end.html
10. “Second Quarter 2018 Survey of Professional Forecasters,” Federal Reserve Bank of Philadelphia; https://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/2018/survq218
11. “U.S. Inflation Is Not a Cause for Alarm Just Yet,” Financial Times; https://www.ft.com/content/80371472-4d26-11e8-97e4-13afc22d86d4
12. “Impact of Inflation and Interest Rates on Exchange Rate Trends,” FXCM Market Insights; https://www.fxcm.com/insights/exchange-rate-trends/
13. “How Does Inflation Affect Exchange Rates?” Inflation Calculator; https://inflationcalculator.ca/how-does-inflation-affect-exchange-rates/
14. “The Globalization of Inflation: The Growing Importance of Global Value Chains,” Bank for International Settlements; https://www.bis.org/publ/work602.htm
15. “Effects of the Internet on Inflation: An Overview of the Literature and Empirical Analyses,” International Monetary Fund; https://www.imf.org/~/media/Files/Conferences/2017-stats-forum/session-3-coffinet.ashx
16. “As the Fed Deliberates, Amazon is Making Its Job More Difficult,” Wall Street Journal; https://www.wsj.com/articles/u-s-shoppers-wield-smartphones-to-keep-a-lid-on-consumer-prices-1513036486
17. “The Impact of Inflation on Management Decisions,” Foundation for Economic Education; https://fee.org/articles/the-impact-of-inflation-on-management-decisions/
18. “The Impact of Inflation on Management Decisions,” Foundation for Economic Education; https://fee.org/articles/the-impact-of-inflation-on-management-decisions/
19. “The One Area of the Market that May be Secretly Wishing for Inflation – Retail,” CNBC; https://www.cnbc.com/2018/05/15/one-area-of-market-that-may-be-secretly-wishing-for-inflation--retail.html
20. “Global Pricing Issues and How to Solve Them,” BlackCurve; https://blog.blackcurve.com/global-pricing-issues-and-how-to-solve-them
21. “Effects of Inflation on Businesses,” InflationData.com; https://inflationdata.com/articles/2017/06/07/effects-of-inflation-on-businesses/
22. “Who Takes the Inflation Strain and Pain in the Supply Chain?” Rathbones; https://www.rathbones.com/knowledge-and-insight/who-takes-inflation-strain-and-pain-supply-chain
23. “Is Your Portfolio Fit for the Future or Fashioned on the Past?” EY; http://www.ey.com/Publication/vwLUAssets/ey-ccb-18-edition/$File/ey-ccb-18-edition.pdf
24. “Who Takes the Inflation Strain and Pain in the Supply Chain?” Rathbones; https://www.rathbones.com/knowledge-and-insight/who-takes-inflation-strain-and-pain-supply-chainx
25. “How Marketers Can Manage Price Inflation,” Harvard Business Review; https://hbr.org/2008/06/how-marketers-can-manage-price
26. “Global Pricing Issues and How to Solve Them,” BlackCurve; https://blog.blackcurve.com/global-pricing-issues-and-how-to-solve-them
27. “Making Your Company Inflation Ready,” Boston Consulting Group; https://www.bcg.com/documents/file72671.pdf
28. “Who Takes the Inflation Strain and Pain in the Supply Chain?” Rathbones; https://www.rathbones.com/knowledge-and-insight/who-takes-inflation-strain-and-pain-supply-chain
29. “UCLA Forecast Sees ‘Regime Change,’” Global Trade;http://www.globaltrademag.com/global-trade-daily/ucla-forecast-sees-regime-change