Businomics Blog

Housing Prices: Still Headed Down

The latest news is really bad for developers selling houses:

That decline reflects two things: first, that we builders have constructed far more homes than Americans need, and second, that they are facing reality that there are too many homes.  To sell, you need to cut the price.  Here's how the supply of new homes looks:

That horizontal line is the average inventory of unsold homes.  At the rate we're going, well get there in June 2010.  Maybe a little faster, or a little slower.  But not next month, or even next year.

4 Indications that it is Time to Start Hedging Your Forex Risk

(Due to the large fluctuations we've had in foreign exchange rates recently, I invited Heather Johnson to contribute this post.  Contact information is at the bottom of the article.  Thanks, Heather.)

Large multi-national companies that conduct trade around the globe and do so in a number of currencies have known for decades the importance of hedging Forex risk. These corporations have millions or even billions of dollars to lose if they underestimate the importance of this practice, so they have led the way in this field. However, big businesses aren’t the only one who can benefit from an examination of their dealings in foreign currency. Even the smallest companies should start hedging Forex risk if they have any international commerce. Though the amount of money at stake is probably smaller than that of larger enterprises, the effect that a loss due to Forex naiveté can have on a small business can be devastating. Here then are four signs that you should start hedging your company’s Forex risk.

1. When you have substantial foreign investment exposure: Many companies, including small businesses, look to foreign investments simply as a way to diversify their portfolios. Other, more aggressive companies often seek out foreign investments as a way to receive larger returns in an economy that they believe to be more robust than their domestic economy. These can be useful and successful strategies, but any enterprise following this route must take into account the risk involved with investment in foreign stocks. When a company invests in a foreign stock, they are not only taking on the speculative risk involved with any such investment, but they are also exposing themselves to foreign exchange rate risk. Even if a company achieves a speculative profit because of the increase in price of a foreign stock, the investment could actually sustain a net loss. This could happen if a devaluation of the foreign currency takes place between the period that the company purchased the stock and when they sell it. Therefore, it is important to place a foreign exchange hedge to help manage the Forex risk that accompanies any foreign investments.

2. When you have substantial interest rate risk exposure: To help explain how interest rates can affect your Forex exposure, let’s first examine how arbitragers deal with them. Arbitragers are investors who attempt to take advantage of interest rate differentials between the foreign exchange spot rate and either the forward or futures contract. They can work either end of this equation, when they feel that one of these is either to high or too low. A simple example of how an arbitrager can make money doing this is by selling when the carry cost he can collect is at a premium to the actual carry cost of the contract sold. In this way, arbitragers can make huge profits from even small price discrepancies due to interest rate differentials. If money can be made from these differentials, then money can be lost if you are not paying attention.

3. When you have substantial foreign exchange rate exposure: Even when conducted in relatively small amounts, buying or selling of any goods or services which are denominated in foreign currencies can immediately expose you to a substantial foreign exchange rate risk. Therefore, some foreign exchange rate risk exposure is common to almost all that conduct even a small amount of international business. When conducting these transactions, a firm price must usually be quoted ahead of time for the contract. This quote will be given using a foreign exchange rate that is deemed appropriate at the time, but this does not mean that the foreign exchange rate will be the same at the time payment is received. To manage this foreign exchange rate risk, it is best to place an appropriate foreign exchange hedge.

4. When there is the potential for substantial losses or gains: The final time when a hedge      should be placed is when there is the maximum potential to either lose or make a lot of money; the difficult part is figuring out when this is. For example, if a currency is lower than it has ever been in your lifetime, it is probably not the best time to hedge further losses. However, it might be an excellent time to hedge upside risk on this fallen currency. With the recent decline in the US Dollar, this is something that all companies, even the smallest ones, should take into account when      considering how to hedge their Forex risk. A good hedge could put you on the road to prosperity, while a hedge in the wrong direction (or no hedge at all) could put you out of business.

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Heather Johnson is a freelance finance and economics writer, as well as a regular contributor for CurrencyTrading.net, a site for currency trading and forex trading information. Heather welcomes comments and freelancing job inquiries at her email address heatherjohnson2323@gmail.com .

The China Price: More Evidence of its Demise

An AP story confirms what the Businomics Blog reported one day earlier: the end of "the China Price."  (Hat tip to the China Law Blog.)

... American toy makers, who rely heavily on Chinese factories, expect prices to increase 5 to 10 percent for the 2008 holiday season, largely because of rising manufacturing costs.

Costs in China are climbing nationwide, but the greatest pain is being felt in the south, where about 14,000 Hong Kong-run factories could close in the next few months, said Polly Ko of the Economic and Trade Office in Guangdong, which neighbors Hong Kong.

Let me reiterate: this is not the end of Chinese manufacturing, or Chinese exports to the U.S.  But the low-hanging fruit has been picked.  The middle-hanging fruit will be a little more expensive to harvest.

Inflation Seriously Bad

Today's news on producer prices is definitely bad.

This comes on top of last week's disappointing CPI data.

There is a substantial time lag between what happens in the economy and inflation, so we're really seeing the economic strength of last spring in the data here.  There's reasonable hope for inflation not worsening in the coming months.

However, the Fed's stimulus, starting last August, will push inflation up some time next year.  I'm increasingly fearful that the Fed has lost control; that they will swing between over-correcting with stimulus, to over-correcting with contraction.  If that fear is realized, look for a far more cyclical economy than we have enjoyed the last 25 years.

Beautiful Chart

I thought I had seen it all, but here's a beautiful chart from the New York Times (hat tip to The Big Picture).  Do not look at this; go to the Times story, because the chart has good mouse-overs there.

Business Turnarounds: Sometimes It Looks Easy

I've been watching a business turn around.  I had not expected it to happen; in fact, I had predicted just the opposite.  The previous owner was a friend of mine, and I knew he wasn't making much money.  When he told me he had a buyer, who was purchasing the inventory AND paying some good will, I said, "Try to sign with a straight face; then cash the check as soon a humanly possible."

The new owner has struck a balance between great customer service and not wasting time.  When I have a technical question, he's happy to take however much time I need.  When my question is answered, he's off to the next issue.  That's actually rare: the people who love talking to customers often never stop talking, and thus never get much done.

The new owner has also set up an Internet marketing site.  I thought that was a waste of time--it's a fairly competitive field.  He's making it work, however.  And the higher volume of business he does thanks to the Internet sales helps his overall profit margin.

All too often I think like an economist: markets are efficient.  What I keep seeing, over and over, is that many businesses are not run very well, and as a result, other businesses can make big bucks by simply doing the basics right.

Seth Godin made that point recently in his blog.  He described his advice to real estate agents suffering from a downturn, and explained how they could build stronger businesses by ultra-niching themselves.  Excellent advice.

I spend a lot of time talking about the external forces impacting a business, and those external forces are certainly strong.  But internal talent is even stronger.

Incentive Systems: Markets, Medicare, and Your Business

"Markets and Medicare" is a great article in today's Wall Street Journal by my good friend John Goodman, president of the National Center for Policy Analysis.  The article has value beyond the Medicare debate, but let's first key in on those issues.  Dr. Goodman explains how medical costs can be lowered and health outcomes improved by freeing doctors, freeing patients, and freeing entrepreneurs.  Our rigid compensation system often will not pay for the most cost-effective treatment methods, so we get locked into expensive and less effective treatments.  Not good, of course.

If you're not interested in Medicare, here's how you should read the article:  your current relationships with employees, vendors, joint venture partners, and customers may also be too rigid.  If someone in the network of relationships around your company has a new idea, will the compensation structure allow that idea to flourish?  Do cost savings techniques get rewarded, especially if they increase customer satisfaction?  It may be time to take a fresh eye to your contractual arrangements.

The essence of economic progress is the Trial and Error economy (described in a series of articles listed here, my favorite of which is this one.)  Successful companies set up systems to encourage lots of little experiments in cost savings and customer satisfaction.  The experiments measure results, so that the winners are pursued, the failures are dropped, and progress is continuous.

End of the "China Price"

In December 2004, Business Week magazine published a special report on The China Price:

They are the three scariest words in U.S. industry. Cut your price at least 30% or lose your customers. Nearly every manufacturer is vulnerable -- from furniture to networking gear. The result: A massive shift in economic power is under way.

That certainly happened--but it's over.  Inflation is accelerating in China.  Although the consumer price index has been pushed up by food prices, factory prices are up by about six percent.  (More details at the Times.)

In a change not widely recognized in this country, the yuan has appreciated against the dollar by about seven percent in the past year.

So the same old stuff is about 13 percent more expensive in dollars paid by the American importer.  However, that importer may be spending more to verify the quality and materials used by the Chinese manufacturer.  An importer would be crazy not to have a formal testing and evaluation program in place.  That adds to the cost.  It really should have been a cost of doing business of a few years ago, but many companies thought they could cut that corner--turns out not a good corner to cut.

At the same time that China prices have risen, U.S. producer prices for non-energy, non-food goods are up only 2.1 percent.  The pendulum is swinging the other way.

Business strategy implications:  If you have not been outsourcing to China but are thinking about it, give the issue less urgency.  If you have a successful outsourcing program, you should test the waters with some U.S. suppliers, to see if your China source is still the best buy.  I say test the water because good vendors should not be discarded casually, regardless of their nationality.  (Also make sure that you are doing proper product testing and evaluation, in case that's not obvious to you.)

Economic implications:  American manufacturing companies will have a slightly easier time competing with the Chinese.

Will China's Economic Growth Slow ?  Yes, but not by a lot.  They'll lose some business they otherwise would have had, but solid growth is still most likely.

Social Networks for Business

The Wall Street Journal interviewed Jerry Sheer, CEO of Sparta Social Networks, in this article (subscription required) Unfortunately, neither the reporter nor the interviewee really made the case for social networks as a profit-increasing tool.  But the case is there to be made.  Try my article, "Business Uses for Web 2.0: How Companies Can Help Their Customers and Their Employees While Cutting Costs," transcribed from the Businomics Audio Magazine.

Economic Stimulus Plan: How Much Will Each Job Cost?

The New York Times reports that the stimulus package $168 billion stimulus package will generate an estimated 500,000 new jobs.  Greg Mankiw does the math:

"In other words, each job created adds $336,000 to the national debt."