Memo to the Fed: go read the conference calls of Action Alerts PLUS charity portfolio holding Apple (AAPL), Johnson & Johnson (JNJ), 3M (MMM) and DuPont (DD). Listen to what they say. If you do, you will regret that you raised rates in the name of inflation, because there is none. All your actions have done is sacrifice our jobs on the international altar. You just don't know it yet, because you haven't done the homework.
When you raised rates you basically caused a spike in the dollar around the globe that has put our international companies at a shocking disadvantage vs. where they were before the rate hike.
Now, it wouldn't matter that much if everyone else were just staying even. But the rest of the world is slowing so fast at the exact same time that the Fed is making the dollar go through the roof, that it's almost as if the Fed is saying "we need to put an additional tariff on our goods beyond what these other countries are doing with their own currency debasement. We will help your local merchants by making it harder and too expensive for U.S. businesses to make sales."
That's right; if the Fed had done nothing at all, many of our international companies would have seen a pretty nasty quarter-over-quarter foreign exchange related decline, but the Fed's hike jacked up the dollar against so many important currencies, especially emerging market currencies, that we are just beginning to see the after effects. Trust me, if you go through the calls, you can see exactly how damning this quarter point was to our businesses.
Now, all of the U.S. companies that do business overseas have pretty much just used the "constant currency" vs. actual numbers as an explanation for this phenomenon. It's been heard so many times that it makes your eyes glaze over. Procter & Gamble (PG) seems to realize that. So it spent a tremendous amount of time and energy going over the issue on its amazing conference call, the one that saw organic growth jump 300 basis points from minus one to plus two in a single three-month period.
"Foreign exchange is a near-term reality that has gotten significantly worse," most recently, P&G's CFO Jon Moeller explained on the call. We're doing our best to offset FX impacts with productivity savings and pricing while continuing to make investments in brand equity, innovation, trial and value equations."
But the currency hits are coming swiftly and severely and just can't be managed with any real effectiveness. "When we talk about foreign exchange impacts," he explains, "we're sometimes asked why we don't simply hedge these away. It's a very valid question and something we look at internally and with a different set of eyes and ears as we prepare our financial plan."
Moeller than goes on to detail why P&G took a $300 million hit because of the strong dollar and was helpless to stop it. First, "up to two-thirds of our foreign exchange losses and a significant amount of our forward exposure is in currencies that are either non-deliverable or are very difficult to hedge: the Argentinean peso, Venezuelan bolivar and the Ukrainian hryvnia are three examples."
Second, "hedging is neither free nor cheap. Currency volatility in itself increases, sometimes in a significant way, this cost. So when you want it most it becomes difficult to afford." Finally, "it solves nothing longer term. It also does nothing to help restore margin structure of the business. A hedge simply defers volatility. When the instrument expires, you have the same hit with the same margin impact you would have had, had you not hedged."
Then to explain the pernicious nature of these currency moves, which were exacerbated by the Fed and would have slowed sales plenty on their own, Moeller walks you through a typical transaction in a country where the currency has gone haywire, especially post Fed hike. Argentina. Here's a country with a currency that's been devalued between 30% and 40% very recently, a slashing that hurt both PG and Kimberly Clark (KMB) a great deal.
I loved the way he walked you through what happened by examining the issues facing its core Gillette business. First: foreign exchange changes increase the cost of non-Argentinean peso denominated inputs. "We import, as an example, Gillette blades and razors from Mexico into Argentina. Widening of the cross-wave between the two peso currencies increases the Argentina unit's cost of razors and reduces profits." Secondly, he points out, there's a balance sheet revaluation. So to continue this amazing razor example, "while razors produced in Mexico are being transported and are moving through the customs process in Argentina, our Argentinean business holds a Mexican peso denominated payable on its books. At the end of every quarter, payables and receivables balances are revalued at current spot rates. Gains or losses from revaluing transactional balances flow through the SG&A and are included in core earnings per share."
The last forex nightmare? "Income statements of foreign subsidiaries like Argentina that do not use the U.S. dollar as their functional currency are translated back to U.S. dollars at the new exchange rates."
How much do those three touch points hurt the business of selling razor blades in Argentina? "The Argentinean peso transaction, balance sheet revaluation and translation impacts have been and are projected to be significant, at about $70 million, $50 million and $30 million after tax." Holy cow! That's the real hit. Right there. That's what the Fed is aggravating when it raises rates, that incredibly difficult thicket for every U.S. company doing business overseas.
This type of currency disconnect is happening at electric speed all over the world, and who is the biggest loser? Why, it is the American worker. That's because, like it or not, PG has to find a way to make its numbers to be able to please its shareholders, as well as continue its long tradition of raising dividends. The company just increased its dividend for the 59th consecutive year; over the past five years, the company has returned $60 billion to shareholders in the form of dividends and buybacks.
If it is going to get hurt in Argentina like it just described or any of the counties that it does more than 60% of its business in, PG will see itself having no choice but to whack costs, and the costs will be largely in the United States. PG has always tried to reduce the cost of "non-manufacturing overhead." PG's very much a part of the new economy.
I think the Fed looks at the business cycle in analog terms, as Gary Cohn, the COO of Goldman Sachs said recently at a Bloomberg panel at Davos, and the real economy is growing digitally. What does that mean? PG explains that, too: "Continued digitization has been and will be a big enabler of our overhead in manufacturing enrollment efficiencies. We're reducing non-working marketing expenditures, costs that do not impact reach, do not impact frequency."
In other words, it is a heck of a lot easier to fire people now more than ever and not skip a beat when it comes to expanding sales.
How does it show up? Just take its impact on one industry: advertising. What's PG doing? "Last year we reduced the number of agencies we work with by nearly 40% and cut agency and production spending by about $370 million. We're aiming for an additional $200 million of agency-related savings this year."
That's jobs disappearing before our very eyes.
Now, the purists out there will say: "how dare you blame all of this on the Fed?" I'm not. That's simplistic. I am just contending that Procter & Gamble is going to make up for these forex losses somehow, and it is going to do it by cutting people where it is most easily about to cut them, right here in the United States. This is happening without the "help" of the Fed.
But with it, the trend is being accelerated and exacerbated.
Believe me, I could have been speaking about every international company that is based here when I am talking about these moves. Kimberly Clark, Johnson & Johnson, 3M, IBM (IBM), DuPont, they are all struggling with these same issues. They need currencies to calm down, but the Fed with is "maybe one, maybe two, maybe three maybe four" hikes has insured a level of turmoil that you would only dream of if you were a nemesis of American business.
As it is, things are tough enough already. But as Tim Cook said on the Apple call, we are experiencing "extreme conditions unlike anything ever experienced in Brazil, Russia, Japan, Canada, Southeast Asia, Australia, Turkey and the eurozone."
Did I leave anyone out?
So, sure, listen to all of those people who come on air and tell you how can a quarter of a point really do anything? How can it really impact the U.S. economy? And then go listen to the conference calls. Every company that has significant foreign operations is going to look at home and find places to digitize, which is the new code for creating productivity by using software not people.
When you do, you will realize that the world is in crisis and the only country that can do anything about it because it is strong -- the U.S. -- has, rather ignorantly, decided to help out by donating our profits to other countries and having our workers here sacrificed to make up for them.
And we wonder why growth has slowed here. It was meant to. In the name of what? Let me know, Fed, if you can articulate it. I know I sure can't.
Thanks writing colleague Matt Horween for pushing this concept along at me! The working person must play a role in Fed policy, not just the banks that needed higher rates.