The Currency Wars and UK Motor Retailers


Dealers know that currency exchange rates play a significant role in their business success. During last year’s UK Scrappage Scheme, budget brands were the retail consumer’s favorite – but not all of them: the winners needed the right exchange rate as much as the right product offer. Those with weak exchange rates such as Kia and Hyundai, who price using the Korean Won, fared much better than brands such as Proton, who faced the added burden of a strong Malasian Ringgit, and brands like Daihatsu from Japan. The picture was similar across all segments: brands with strong currency’s did worse with like for like products than those with weak ones. (See UK Market Round-Up to June 2010).

So, with recent headlines suggesting the risk of ‘currency wars’ over financial policies, what are the implications for UK retailers?

The players are China (plus the Developing Markets) versus the US (plus the financially distressed markets). Or, to put it another way, the conflict is between countries who save and invest and those who spend and consume. Some europeans, like the UK, are with the US; others such as Germany are broadly with the Chinese.

China – along with every other country – manages its currency exchange rate relative to the globe’s major reserve currency, the US Dollar, as well as against others they might trade with, such as Sterling, the Euro and the Rouble. The US charges China with holding down the value of their currency. As a result, US citizens buy ‘cheap’ Chinese products, instead of US products. And, in the opinion of the US, that ‘costs America jobs’.

Strangely, the way that the chinese manage the exchange rate is by buying US government bonds, which of course the US needs. According to the US Treasury, as of August 2010, China is owns $868.4BN of US Debt, around 21% of the total. The Japanese own about 20% and the UK about 10%.

One  analysis is that since the 1990’s the US and China have had a cosy financial relationship where, in return for buying their government debt, the US gives China access to the world’s biggest consumer market. This provides income for China’s exporters and employment for millions in China. In return, the Chinese invest their trade surplus in the US which helps to fund the spending. Its like GMAC loaning customers the money to buy GM cars.

So, why has this relationship deteriorated of late? The Chinese argue first, by ‘QE’, quantitative easing (printing money), the US is stoking inflation and, potentially, devaluing their investment. In March 2009 the US Federal Reserve (the ‘Fed’) launched a $1000MN QE package and a second round (‘QE2’) of $600BN in November 2010.  Second, the Chinese say that asking them to increase their Exchange Rate, actually worsens their competitive position even more, by importing inflation. The effect would be to raise China’s prices and lead to falling export volumes. In their opinion, they’re being asked to take two hits – sell less, so your income falls, and watch the value of your savings in US$ decline at the same time. Meanwhile, the US still wants China to buy US bonds, even as they fall in value. Surprisingly, the Chinese response is unsympathetic.

The US position is that China should stop just exporting its own products, but should consume them as well. By raising exchange rates the Chinese consumer could spend  more. In addition, if they had morer money to spend, they could buy US and European products as well.

China is not alone in wanting to resist US economic policy. Brazil, Canada, Germany,Japan, South Korea, Thailand, India and South Africa are all in a similar position to China. They are all exporting strongly, have positive trade balances and a fear of inflation. None of them want investors flooding cash into their markets because returns have collapsed at home. The US is not alone either. The Eurozone’s distressed economies – the ‘PIIGS’ (Portugal, Ireland, Italy, Greece and Spain) would all benefit by being able to export to a growing Chinese consumer market. So too would Britain.

The risk is that the  US Federal Reserve’s actions resemble steps taken years ago by the Bank of Japan (BoJ) when it formally announced its QE policy in March 2001. The BoJ lowered interest rates to almost zero and the yields on 10-year Japanese government bonds tumbled as the central bank bought assets in order to lower credit spreads. This led to a significant expansion in the country’s monetary base (currency in circulation) and depreciation in the Japanese yen, which fell by more than 20% against the pound, euro and Australian dollar between 2001 and 2007. Even now, only Japan has a debt market larger than that of the United States – but, because Japan’s debt represents some 170 percent of its GDP, it has a credit rating no better than that of the better-run states in sub-Saharan Africa.

So, why should you care?

To begin with, the UK Treasury is implementing a similar policy as the US. Currently it has spent £200BN – about 14% of annual GDP – and it is expected to launch its version of QE2 in the next few months. According to Spencer Dale – member of the Monetary Policy Committee and Chief Economist – while the results aren’t all clear, QE did lead to a healthier stock and bond market . Others point out that with inflation already at 3% and savings interest rates below that, the real value of saving is negative. When cash in the bank pays less than zero, there’s no such thing as a risk-free investment.  That may also be pushing up equity and bond markets.

Why might the UK follow the US policy and go in for QE2? To begin with QE1 has produced very few results in the ‘real economy’. Most of the cash given to banks went straight into the equity markets, not into lending to consumers and SME’s – see chart. So, there is pressure to do more. Second, it reduces the government’s cost of borrowing. Under the Maastricht Treaty the UK government cannot sell debt to the Bank of England (BOE). So, it sells it to UK banks, who in turn sell it to the BOE. In effect, the government issued more than an average years worth of debt to itself at low interest rates last year.

Observers point out three downsides to QE. The first is that all this money may find its way into emerging country’s equity markets which has the potential to stoke up a huge rise in their prices. Specifically, countries like South Korea and China – unless thay can resist the inflows of cash – will find their prices rising. That will put at risk dealers who represent brands from those countries. In the worst case, if QE fails, investors in the UK stock market may lose faith and begin to add to the tide of money looking for a home abroad. A domestic stock market slump could spark another recessionary spell, but this time coupled with higher priced imports.

Number two, in traditional economic theory, raising the supply of money on its own always brings inflation. In fact, that is one of the Bank of England’s hoped for side effects. If the supply is raised enough it will end deflation ( price falls in houses and such like) and spark consumption. But, it may bring a large dose of inflation later – much higher than the 2% target . The BOE says it is ‘alive to this threat’, but it will be extremely difficult to drain, say £75BN or £100BN cout of the UK economy quickly, unless you want another recession. In that case, there’s a risk that the UK may experience a severe boom and bust cycle. In turn, that would place many small dealerships at risk of collapse. During the boom phase of the process many dealers will find the import prices of their new product spiralling and their profits shrunk as they try to help buyers bridge the ‘cost to change’. During the bust phase many  will simply run out of cash as their unfortunate predecessors did in the 2007 – 2009 period. 

Number three, it may be worth looking at its potential effect one of the fundamental economic drivers for dealers – the price of oil. Back in July 2008 it rose to $140/barrel. Some observers blamed OPEC, others blamed speculators in oil futures. The price only fell when the global economy slowed. Since then it has recovered and in November 2010 traded at $85. One estimate is that the price will rise again, as QE cash floods into oil-producing markets, which in turn will constrain sales in the UK car market. Back in April 2010, Adrian Rushmore (Link to Adrian Rushmore) from Eurotax Glass put a brave face on it, suggesting that for premium used cars “…the desire for ownership will remain high, and relatively low annual mileage will minimise the impact of high petrol prices.”  If he’s wrong, oil price inflation will undermine used values and sales volumes in all the fuel-inefficient segments. We could get back to the situation in 2008 when premium used car values slumped.

QE does not operate in a vacuum. The revival of concern over Ireland’s financial position, and the fears of contagion to include Portugal and Spain are affecting exchange rates. In the three weeks between the 25/10/2010 and 16/11/2010, the Euro fell 5% against Sterling: good for euro-denominated brands, bad for UK components manufacturing. Similarly the dollar weaked by around 3% against Sterling, with  a similar effect.

In summary, if QE succeeds, imports will be more expensive and – depending on the currency – some brands will lose volume (or margin). On the other hand, the  domestic UK car market demand could rise as the UK comes out of recession. Cars from Spain and Italy – and other Eurozone markets – could all become cheaper. That includes products from both Germany and Eastern Europe. Because the Euro would stregthen against Sterling. If QE fails, broadly, the opposite is likely.


US$ Price of Gold 1995 - 2010

You could of course simply move your money into Gold (see chart). However, keep in mind that the trend in the Gold price is the inverse of the value of the US$ – one is going up while the other falls. If the US gets its way and the Eurozone and developed countries are forced to raise their exchange rates, eventually, the US$ will rise again. Those who buy Gold now – at the top of the market – could face large losses – say $600 – $700 an oz. Don’t say you weren’t warned!