Monday, July 30, 2012

United States Profits and the United States Dollar

I recently discussed the recession in Europe and the impact this recession is starting to have on the United States economy.

In addition to this impact, we are now observing how the decline in the value of the Euro is impacting the profits of United States companies.

The Euro took a nosedive against the United States dollar in May and has remained weak against the U.S. currency ever since.  This can be seen in the accompanying chart.

It is not so much that the United States economy is that strong.  It isn’t. 

But, foreign exchange rates are relative and the current story is that the United States economy may not be that strong…it is just that the economies of the eurozone are that weak…and the leadership in the eurozone is seemingly subject to a similar shortcoming.

For much of the first quarter of 2012, the value of the Euro averaged around $1.32 to $1.34. 

In late April, but especially in May, the value of one Euro against the dollar dropped quite dramatically.  On May 11 the value of the Euro was still above $1.30.  By May 25, the value of the Euro dropped below $1.25.

The “fun” thing about this drop was that I was in Italy during this time and experienced the fall, first hand.

The more important factor is that the decline in the dollar value of the Euro has hurt United States companies as they converted the profits they earned in the second quarter of this year in Europe back into U. S. dollars. 

Interestingly, United States companies did not seem to be hit too hard by the drop in the Euro’s value in the latter half of 2011, probably due to the fact that the Euro moved much more slowly at this time and, coupled with a rise in value during the first half of the year, things seemed to “even out” for all of the year.  Also, eurozone countries had not gone into a recession until the last quarter of the year so the sales of U. S. companies in Europe remained relatively strong.

But, in the second quarter of 2012, the profits U. S. companies earned in Europe were hit pretty hard by the changing value of the Euro. 

For example, Colgate-Palmolive Co, and Dow Chemical presented evidence that the rise in the value of the dollar hurt their second quarter profits.  Colgate, for example, claimed that its bottom line was down by 9 percent due to currency issues.  Dow’s profits also were substantially lower.

Thomas Freyman, chief financial officer of Abbott Laboratories indicated impacted sales figures of his company by about 5 percent.  Yum Brands, Inc. owner of KFC, Pizza Hut, and Taco Bell, claimed that the exchange rate situation lowered profits by about $13 million in the first two quarters of 2012.  And, Snap-on Inc., stated that currency movements in the second quarter reduced sales growth by more than three percentage points. 

Why didn’t these companies establish hedges against such movements?

“The reason why you can’t offset the kind of significant foreign-exchange swings that we had in the second quarter was the speed of the change,” states Ian Cook, chief executive officer of Colgate-Palmolive. 

The thing everyone seems to agree on, however, is that if the value of the Euro remains where it is now, there will be continued losses in the third quarter of this year and possibly the fourth.

Given the political situation that exists in Europe right now, I can’t see the European economy getting much better through the end of the year.  As a consequence, I can’t see the value of the Euro against the dollar appreciating at all through by the close of 2012.

Therefore, I can only suggest that the profits of United States companies will continue to be hurt through the rest of 2012 due to the strength of the U. S. dollar against the Euro. 

Hence, we add one more reason to the list of things impacting the American economy and one more reason why the economic growth in the United States will remain weak in 2012.

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