The global finance systems consists of markets, institutions, laws, regulations, and techniques though which bonds, stocks, and other securities are traded, interest rates are determined, and financial services are produced and delivered around the world (McGraw-Hill, nd). In the globalization of each of these components there exists the necessity for transparency and consistency in exchange rate mechanisms in order for business to make appropriate assessments of their international strategy. This does not mean, however, that exchange rate mechanisms are universal in their methodology and a variety of strategies exist. This paper will broadly divide these strategy types in the way that ‘hard’ and ‘soft’ currencies are defined and consider the use of these currencies in global financing operations in terms of risk management.
Hard Currencies
We shall first consider hard currencies in their definition and general form. A hard currency is one that is generally accepted internationally as a means of payment for goods and services. Hard currencies tend to be associated with developed, industrialized nations whose economies remain relatively stable over an extended period of time and in which fluctuations are relatively predictable and may be accounted for. Such nations tend towards political stability that further stabilizes their economies and thus their currency value. This stability, of considerable value in itself given the lessening of risk in the international environment for those who utilize it, leads to the currency itself being value as a commodity and, in limited supply, its value being increased as a consequence able to purchase more goods, services and other currencies than may otherwise be possible. The classic hard currency in this regard, treated somewhat as a global currency, is the US dollar. This presents advantages for American consumers given that it reduces the cost of some foreign goods and services. However, it places American exporters at a disadvantage by increasing, in global terms, the relative cost of their own products thereby making them less competitive in the global marketplace.
Soft Currencies
Contrasting with hard currency, soft currency is prone to fluctuation given a number of factors affecting their value. Consequently a soft currency may also be known as a ‘weak currency’ that may not be readily relied upon. Its value may fluctuate, for example, given a nation’s political or economic uncertainty (Zillla, 2013). Uncertainty in the value of a currency may, to some degree, be overcome through direct government intervention, in particular through the transparent or semi-transparent pegging of currency value to that of a hard currency, usually the US dollar, though this can lead to a value being set for the currency that is unrealistic and prone to interference given governmental interest in having the currency over- or undervalued in accordance with its own economic strategy (Investopedia, 2013). More transparent and direct pegging puts the currency at the mercy of the value of the US dollar and its own fluctuations. A weak dollar, then, will favor exports over consumption internally, a strong dollar will favor internal consumption over exports as described above in analyzing the US dollar itself. This may not be reflective of the nation’s needs or economic strategies at that point in time and thus increases the risk of instability.
Managing Risks
Given the risks of international trading, currency stability is essential in formulating a suitable business strategy. Economic risk is defined as the danger of a project’s output not generating sufficient revenue to cover operating costs and to repay debt obligations (Investorwords, 2013). Economic risks are segmented into financial factors, which include inconvertibility of currencies leading to foreign indebtedness, and economic factors in such areas as government finance and inflation. Such difficulties may lead to higher taxation or government-imposed restrictions on foreign investors’ or creditors’ rights (Zillla, 2013). These and other factors require strategies on the part of business not only to deal with issues as they arise, but also to secure investment and reliance upon currencies least prone to presenting such risks in the first instance.
Currencies that are excessively over- or undervalued – too weak or too strong – not only affect the economies they represent, but also distort international trade. They will also affect economic and political decisions made by nation’s governments. It is therefore necessary for companies to manage the currencies they utilize in international trade to lessen risks to their profitability that may arise from additional costs being incurred through disruption of their own strategic plans and goals. Moreover, in terms of investment, appropriate use of currencies may increase inward investment thereby keeping interest payments low on loans that may otherwise need to be obtained to cover any shortfall.
Conclusion
In considering how best to utilize foreign currency in business strategy formulation, the benefits that come with hard currencies in their stability is immense. They permit outcomes to be more predictable in terms of their strength, reliability and consistency when compared with the unpredictability and weaknesses associated with soft currency. Foreign investment may be desirable in terms of its returns in both corporate and governmental strategic thinking but has the disadvantage of putting many factors outside the managers’ control. Thus the stability of hard currency gives it exceptional value in undertaking any such strategy.
References
Global Financing-Hard and Soft Currency retrieved on February 20, 2013 from
http://ezinearticles.com/?expert=Rob Zillla
Part 1 The Global Financial System in Perspective. Retrieved on February 20, 2013 from
http://www.highered.mcgraw-hill.com/sites/di/free/0072957395/250896/rose_chap.
Hard Currency Definition retrieved on February 20, 2013 from
http://www.investopedia.com/terms/h/hardcurrency.asp
Soft Currency Definition retrieved on February 20, 2013 from
http://www.investopedia.com/terms/s/softcurrency.asp
