Suppose the value of the dollar rises or gets stronger against the yen (the currency of Japan). What impact will this have on U.S. and Japanese businesses? Goods exported from the United States will become more expensive because people in Japan will now need more yen to purchase each dollar. This means, for example, that the cost of a $40 pair of jeans made in the United States will become more expensive for the Japanese consumer. Japanese consumers will buy fewer U.S. goods, like jeans, and U.S. exports to Japan will fall. Of course, this will hurt U.S. businesses selling their products in Japan.

At the same time, however, the stronger dollar will cause a decline in the relative price of Japanese goods for U.S. consumers because fewer dollars will be needed to purchase each yen. Thus, resulting from the change in currency exchange rate, the United States will import more Japanese goods, and U.S. businesses will lose market share to Japanese companies.

This example of Japanese and U.S. trade shows how a currency ­appreciation—an increase in the exchange rate of a nation’s currency—causes the relative price of imports to fall and the relative price of exports to rise. When currency appreciates, the currency becomes stronger. By contrast, a currency depreciation—a decrease in the exchange rate of a nation’s currency—has the opposite effect on the relative prices of exports and imports: Exports become cheaper and imports become more expensive. Sometimes the government issuing the currency decides to devalue its currency. This deliberate adjustment of the value is different than depreciation, where the change is happening as a result of outside forces.

Fluctuating exchange rates also affect multinational firms in other ways. Many companies feel pressured to shift their production to countries with weak or low-valued currencies to take advantage of lower costs of production. For example, a weak Chinese currency reduces labor costs in China. If a firm doesn’t shift more of its production to China but its competitors do, then its costs will be higher, and the company will lose global market share.

Exchange rate changes can also create trade deficits and trade surpluses for a country. A trade deficit exists when the value of a country’s imports exceeds the value of its exports. For example, a stronger dollar can create a trade deficit for the United States because it can cause export prices to rise and import prices to fall. A trade surplus occurs when the value of a country’s exports exceeds the value of its imports. What do countries do when they experience a trade surplus? Often countries that trade in raw materials, such as oil or diamonds, find the commodity price fluctuates a great amount from year to year. So, taking the pool of money that exists in the year of a trade surplus and investing it would be a good strategy. Sovereign wealth funds (SWFs) are government investment funds that do just that. They are managed separately from the official currency reserves of a country. In 1953, Kuwait established the first SWF, which is now worth almost $300 billion. Many countries now have SWFs, including Norway, China, Saudi Arabia, and Singapore. The amount held by all SWFs is currently more than $6 trillion.20

SWFs can invest in anything they want, and sometimes the investments of SWFs stabilize and allow foreign companies to expand. But during the recent credit crisis, many SWFs invested in collapsing banks in Europe and the United States. In fact, more than $69 billion was invested in a range of struggling banks and financial institutions.21 The oil-rich emirate of Abu Dhabi made a $7.5 billion investment in the U.S. banking firm Citigroup. The political implications of this level of investment make some uneasy about the rapid growth of SWFs. China’s fund has made significant investments in major U.S. financial firms. How might that impact the political tensions between the two countries? What if an Arabian SWF invested in a shipping company, giving it control of U.S. ports?

Exchange rates can be manipulated or fixed by governments. For example, China has fixed its currency to a rate that is weak compared to the dollar. This means Chinese exports to the United States are cheap and imports from the United States to China are expensive. As a result, the United States faces a huge trade deficit with China. The U.S. government has been trying to persuade China for years to allow its currency to “float,” or change in response to changing market conditions. Indeed, most countries operate under a freely floating (or flexible) exchange rate system, a system in which the global supply and demand for currencies determine exchange rates. Many specific factors affect the demand and supply of a nation’s currency, such as changing interest rates, tax rates, and inflation rates. Generally, however, changes in exchange rates in a freely floating exchange rate system reflect a country’s current economic health and its outlook for growth and investment potential.

The problems with floating exchange rates are that they can create relative price changes outside the control of international businesses and engender risks of losses because of rapid and unexpected changes in exchange rates. For example, in the 1980s, Japan Airlines purchased several 747 airplanes from Boeing and agreed to pay in U.S. dollars. In the interim period between signing the contract and the delivery of the planes for payment, the value of the dollar rose dramatically. The airline company had to pay a lot more money than anticipated for the airplanes, and it almost went bankrupt. This example illustrates that unanticipated exchange rate changes can pose huge risks for international businesses.

Governments also reserve the right to restrict the convertibility of their currency. It’s not uncommon for a developing country to have a nonconvertible currency—currency that can’t be exchanged for another currency. For example, the national currency in Morocco is the dirham. It cannot be converted outside Morocco’s borders, so visitors want to spend every dirham they have before ending their Moroccan vacations. Governments with nonconvertible currencies often fear that allowing convertibility will result in capital flight, the transfer of domestic funds into a foreign currency held outside the country. Capital flight would deprive the nation of much-needed funds for investment and development.

Global companies can still do business with countries that have nonconvertible currencies through the use of countertrade. Countertrade is a form of international barter, the swapping of goods and services for other goods and services. Currently, countertrade may account for as much as 10 to 15 percent of total world trade. Companies engage in countertrade because of necessity and profitability. Examples of companies that have undertaken countertrade include Goodyear, GE, Westinghouse, 3M, General Motors (GM), Ford Motor Company, Coca-Cola, and PepsiCo.22

Many developing countries are experiencing more rapid growth than advanced economies are, and they have hundreds of millions of eager new customers ready to put their money into the global market. However, some developing countries still lack the basic infrastructure necessary for the effective transportation of goods or lack access to dependable electricity. They may also be lacking in modern communication systems. The implications for companies doing business with these nations are clear. For example, the types of food products offered for sale would have to be altered and packaged differently. The modes of advertising would shift from television to radio, and marketing a product via the Internet wouldn’t be effective because few customers would own a computer. Advertising delivered via mobile phones would be critical in these countries. African countries are an example.

International businesses prefer free market economies to state-run or socialized economies because the bureaucratic red tape drives costs up. Other economic factors include the debt load of a nation (the amount of debt a country has), its unemployment and inflation rates, and its fiscal and monetary policies. A country with high unemployment rates and runaway inflation can signal that the nation is unstable and risky to do business in.

Several socioeconomic factors also need to be taken into account, such as the demographics of population density and age distribution. The birthrates of many developing countries are high and offer exciting opportunities to toy manufacturers such as Mattel. Other socioeconomic factors that firms must consider include income distribution, ethnicity, and the cultural behaviors of a community.