Home > The Merk Perspective > Merk Insights > March 18th 2004

BMW bets on a stronger Dollar - a fatal mistake

Axel Merk, March 18th 2004
This article was written by Merk Investments before the Merk Hard Currency Fund was launched.

BMW yesterday announced that it will discontinue its currency hedging activities. BMW believes the Euro's proper exchange rate should be at $1.10, and that the Euro is overvalued.

In our view, this attitude is fatal:


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The strength of automotive manufacturers is in the production and distribution of cars, not in the prediction of exchange rates.
Hedging is costly. We can imagine that the currency hedges have become so expensive that top

managent at BMW has decided that they rather accept the currency risk. The obvious problem is that their competitiveness suffers even further should the dollar fall further. This is not the appropriate remedy for overinvestments in other areas.

An alternative to hedging is a greater emphasis on "natural hedges", the local production in the US. BMW has

a strong commitment in South Carolina where it produces the X5, Z4, formerly also the Z3, as well as the BMW318i. If BMW can avert sufficient currency risk through this facility, then a reduction in their hedging activity may pose less of a risk than it appears.

In our view, the sole reason for the recent recovery in the dollar lies in that too many thought the dollar would decline, causing a counter reaction, triggered by Asian central bank interventions. As long as the US carries a twin budget and current account deficit in excess of 5% of GDP, as long as countries such as Japan and China purchase hundreds of billions in US Treasuries (Japan purchased $70 billion in January alone) - and have to give up this game at some point - the dollar will have little chance to stabilize long-term. Even Russia has intervened with over $10bn in the currency markets this year to support the dollar!

Add to that that the US consumer continues to have the highest debt level ever, except nowadays this debt is carried with extremely low interest rates - meaning that it is exposed to the risk of rising rates. At the same time, commodities prices are rising. Firms cannot pass on the higher costs to a streched consumer, thus create only very few jobs despite $1000 billion worth of tax cuts and increased government spending. Without jobs, consumption cannot be maintained.

Already now, 7 year car leases with 0% financing are being offered to convince the US consumer to purchase one last car.

All of this means that BMW and its competitors will have a difficult time in the coming years, and that additional risks through currency hedging is not something they can afford. This could be a fatal blow to BMW should the gamble not pay off.

We have stopped investing in the German automotive industry some time ago, especially because of the dollar exposure, but also because the US consumer needs a break after a boom that lasted over 10 years; the massive consumer stimulus of the US government may mean that this "break" could be rather severe when it finally comes.


Analyst Disclosure:
Neither Axel G. Merk, his family, nor Merk Investments, nor Merk Investments clients hold BMW shares.

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