If you want to understand how this month’s coronavirus-fueled chaos in financial markets is impacting America’s real economy, look no further than McElroy Manufacturing and how the surging dollar is affecting it.
The Federal Reserve and other central banks scrambled Friday to ensure that the world’s reserve currency remains a beacon of stability in the financial system. But for Chip McElroy, the company’s president and CEO, the greenback’s rapid appreciation against the Australian dollar this week was already creating a real world debacle for the 66-year-old family-owned company based in Tulsa, Oklahoma.“We have goods on the water right now to Australia and that currency has devalued 15% in the past week and our channel partner there can’t absorb that,” he said in an interview. “Even if he could, it knocks our products out of competitiveness in that marketplace. We’ve got huge exchange rate exposure now.”
A strong dollar is often viewed as a drag on America’s exporters as it raises the prices of their goods internationally and this time looks no different.
What’s different now is the suddenness. Exchange-rate issues tend to creep up slowly from global differences in central bank policy rates and other macroeconomic effects.
The rapid swings in currency markets due to this latest crisis have made those problems appear at hyper-speed for companies like McElroy, which makes equipment used to fuse pipe sections together in energy, mining, and water projects.
The strengthening dollar in recent years has been one of the things fueling President Donald Trump’s attacks on the Fed and his calls for an aggressive cut in rates.
In an effort to cushion the blow to the U.S. economy the Fed has done exactly that, bringing rates down to near zero. Yet the demand for dollars around the world has also surged with the crisis, offsetting what would have been the normal pressure for the currency to weaken and rekindling concerns for manufacturers doing business internationally.“Your foreign sales from a U.S. person’s perspective have dropped drastically,” said Ashley Groves, founder and CEO of Deaglo Partners LLC, a foreign exchange advisory firm. “Imports like raw materials charged in U.S. dollars have gone up 20% -- or more than that in some cases. Anyone that is ultimately importing in a U.S. dollar denominated product is absolutely going to be crushed, and it doesn’t look like that’s going to bounce back anytime soon.”
The impact isn’t only on American exporters. In South Korea, for example, brokerages are getting hit by a surge in margin calls on their dollar-denominated derivatives positions. That’s prompted scrutiny from regulators and, in turn, consequences for Korean companies with dollar-denominated debts echoed in many emerging economies now seeing rapid outflows.The dollar has been rising sharply against commodity currencies like the Australian dollar and traditionally has a negative correlation with oil prices. As crude prices fall the U.S. dollar tends to appreciate.There is potentially good news for companies like McElroy. Much of the appreciation in the currency has been driven by risk aversion, said Robin Brooks, chief economist at the Institute for International Finance.
“If things go back to normal, I would expect to see a reversal in the recent strength,” he said. “These risk aversion moves can unwind quickly.”
‘Shock to Demand’
Brad Setser, a former U.S. Treasury official and self-described currency hawk now at the Council on Foreign Relations, said he was more worried now about the potential stresses in financial markets that a strong dollar was reflecting than the traditional impact on America’s export economy.The “bigger problem is that a very high share of U.S. exports are aircraft and aircraft engines and there has been a real shock to demand” due to the slowdown in air travel, he said. “In normal times I would worry about the conventional channels by which a strong dollar reduces demand for U.S. exports. But these aren’t normal times.”
In the case of the $400,000 order of McElroy equipment headed to Australia, the company is hopeful that it can work something out with its distributor.
That doesn’t eliminate a growing list of other issues racing onto McElroy’s agenda: from a collapse in crude prices that has frozen investment in American petroleum projects to keeping the company’s 320-strong Tulsa-based workforce safe from the Covid-19 virus.
“All of this discussion of sending everybody home and shutting down production -- I just sit there somewhere between dismay and horror,” McElroy said. “What does that look like? What does that mean? And how do we recover from that?”
Already, the company’s daily order book is a third smaller than it would be in normal times and McElroy and his fellow executives see an impact developing that is likely to be bigger than the 2008 crisis, when year-over-year sales fell by 45%. The cost of a two-week closure would be $3-$4 million in lost revenues and $2.5 million in fixed costs, McElroy says, a significant hit for a company with annual gross revenues of roughly $100 million a year.“We understand where we fit in the supply chain and none of us really have that much control,” he said. “But what is different this time is there is nothing happening around us that feels like it is in control.”
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