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The surprising thing to me, on reading your post, is that currency risk seems to have a significant real effect. Because you export to the US, you want to import from the US, to reduce the currency risk.

Yeah, but as Mike says, it's hard to import your most significant expenses (labour, rent) from the US. I suppose, if you have a need for short-term technical contractors, you could prefer to hire hire US contractors on NAFTA visas.

What do we do about currency risk? Mainly, cry in our beer.

Could you find an importer (or an exporter to canada) and sign a contract that transfers wealth based on the exchange rate movement? There should be other companies (in America probably) who have the exact opposite problem. I am surprised there is not some sort of standard contract for this type of thing.

Seems to me that employees ought to be willing to receive some of their pay in USD. A decent percentage of costs of consumption are tied to USD denominated prices, such as tourism to the USA/Caribbean, electronics, cars, etc.

Great post Mike! Thanks! I'll have to ask more goofy questions in the future. -lol- Before I read this thread I posted the following to the original:

westslope: How would company top brass use the model? From what I understand, it doesn't predict future exchange rates, just what the current one should be - or am I missing something here? -Just visiting

Good call; you are absolutely correct. My bad. I'm the one reading too much into the model's potential application. And though I suspect that oil prices are easier to predict than exchange rate movements, I have no empirical proof that is the case. (Future prices might be unbiased predictors but that doesn't mean that oil prices can be cost-effectively forecast.)

Now an employee in Mike's position could do some extra research, go to the bosses and say: Well it looks like oil (and other commodity) prices are going higher, we should prepare for a stronger Canadian dollar. But the model by itself contains no such potential insight.

Posted by: westslope | April 10, 2010 at 06:03 PM

As to hedging strategies, isn't the most common strategy to allow capital income to take an enormous hit until responses to exogenous foreign exchange shocks work through the market or the firm lowers unit costs? Presumably there are efficiency gains because labour is risk averse.

For those interested in the macroeconomics of oil prices, I highly recommend Prof. James D. Hamilton's econbrowser.com blog post April 10, 2010 Do rising oil prices threaten the economic recovery? Hamilton concludes that current oil prices may slow but do not otherwise threaten the economic recovery.

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