Currency crisis: Preparing your business for shifts in currency stability

Globally, the U.S. dollar is holding on as the most used reserve currency in the world as the International Monetary Fund (IMF) reports that around 60% of global reserves are held in the U.S. dollar. Although it’s impressive that the U.S. dollar is held so highly over other currencies, this approximate 60% is still lower than the 67% reserve rate the U.S. dollar was at two decades ago. The British pound, Canadian dollar and Japanese yen have also gained traction as currencies held in reserve while the Chinese yuan is also joining the mix and seeing an increased presence as a currency in reserve.

Although none of this necessitates a red alert alarm blaring in the background of financiers and fiscally prudent business folk, it’s something to consider and plan for if competing currencies continue to reduce the share held by the U.S. dollar.

What is the worst-case scenario?

Although it’s possible but not likely, the U.S. domestic and global financial ecosystem could face a concerted effort by foreign actors to drive down the dollar’s buying power and presence. Recently, multiple publications have been discussing China’s efforts to move away from the U.S. dollar and base an economic system and global reserves more on their yuan. Common criticism has been that the systems proposed are based on U.S. systems already established and that the yuan’s fractional power as compared the U.S. dollar makes it immediately less powerful and potent than the U.S. dollar.

Should these efforts succeed, however, then the dollar and those holding it would lose buying power. Prevalence and financial holdings would plummet as the value of the U.S. dollar disintegrated. This would, at the worst, result in something similar to what Germany and its citizens faced following World War I, when the German mark depreciated from roughly 160 marks to one dollar all the way down to 4 trillion marks for one dollar. In that time, German retirees’ savings were reduced to nothing, and the currency became no more valuable individually than the paper used in its printing. The effects were catastrophic with Germany facing one of the worst economic crises ever seen in global economic history. That financial collapse led to many years of struggle.

For the U.S., given its size and presence on the global financial stage, it would be like the fall of Rome to the Visigoths in 410 A.D., signifying the end of an empire and the death of innumerable domestic businesses. For domestic U.S. businesses, they would need to have extensive holdings in other stable currencies to survive a crash like this, which most currently do not possess. Again, this is the worst-case scenario and a collapse in the dollar’s value would be devastating but it is highly unlikely unless every country essentially declares financial war on the country that they place collectively 60% of their money in the currency of.

What businesses can more likely expect if the dollar’s stability is at risk

Although a crisis scenario is always possible, U.S. businesses are more likely to face the following impacts:

1. Foreign exchange risk: Businesses that conduct international trade face foreign exchange risk. A weaker dollar could make imports more expensive, hurting businesses that rely on foreign suppliers.
2. Increased cost of borrowing: If the dollar’s stability is at risk, investors may demand higher interest rates to compensate for the increased risk, making it more expensive for U.S. businesses to borrow money.
3. Reduced investment: Like borrowing, investors may also be less likely to invest in U.S. businesses, leading to reduced investment and slower economic growth.
4. Reduced purchasing power: If the dollar’s value decreases, it could lead to higher inflation, reducing the purchasing power of U.S. businesses and consumers. This could hurt businesses that rely on domestic sales.
5. Global competition: A weaker dollar could make it easier for foreign businesses to compete with U.S. businesses, as their products and services become relatively cheaper in comparison.

 

Preparing your business for shifts in currency stability

The best step, and first step, a business owner should take to mitigate risk associated with currency stability is to work with financial experts such as currency traders or financial advisors. A financial expert guides businesses through risk management practices such as diversifying currency exposure, hedging currency risk with currency forwards, options and futures and monitoring exchange rates.

Businesses can also reduce their exposure by focusing on domestic sales instead of relying on exports. This can be particularly relevant for small and medium-sized businesses that do not have significant international operations.

Insurance typically does not mitigate the risk of U.S. currency instability, as it’s not a risk that can be insured against. However, there are some types of insurance that businesses can consider to protect themselves against other risks that may be related to currency instability. For example, trade credit insurance protects businesses against losses due to non-payment by customers. This type of insurance can be particularly relevant for businesses that rely on international sales, where currency instability can increase the risk of non-payment.

Although traditional insurance will not effectively cover the fallout of currency risk, captive insurance serves as an alternative tool. Captive insurance is a form of self-insurance where a business creates its own insurance company to provide coverage for risks that may be difficult or expensive to insure through traditional insurance markets. Some ways captive insurance can enable a business to weather the storm of currency instability include:

 

1. Diversifying risk: Since captive insurance can provide coverage for risks not typically covered by traditional insurance, it can help businesses spread their risk across a broader range of insurance policies.
2. Cost savings: Captive insurance can be a cost-effective alternative to traditional insurance, as businesses avoid the high premiums and fees charged by insurance companies. This can be particularly relevant for businesses operating in areas with currency instability, where insurance costs may be higher due to increased risk.
3. Retention of profits: Captive insurance allows businesses to retain the profits from their insurance policies, rather than paying premiums to third-party insurance companies. It can help businesses build up reserves to manage the financial impact of currency instability or other risks.

 

While businesses cannot completely eliminate the risk of U.S. currency instability, effective preparation can help them mitigate the financial impact. By implementing measures now, businesses can reduce their exposure and adapt to changing market conditions. By being proactive and taking steps to prepare for currency instability, businesses can position themselves to avoid the worst effects of currency fluctuations.

 

Randy Sadler is principal with CIC Services. He may be contacted at [email protected].

 

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