Best Currency for International Trade:
When trading goods internationally, payment can be done in a variety of currencies, so what is the best currency for international trading, especially from the perspective of the seller of the goods to the overseas market.
Ask An Expert
Discussion with renowned global trade expert Murdo Beaton and Abdul Mann, creator of the cloud-based export solution EdgeCTP.
Should I adopt the home currency of my customers when selling my goods to them?
The currency used, or the currency that a business would choose to use with overseas transactions depends on many issues. Here are a few considerations:
- Trade in your own (seller’s) currency. Use this approach if you only wish to receive payment for the amount you quoted in your own currency and do NOT want to risk any currency rates moving against you. A lot of UK businesses, prefer to trade in British Pound Sterling (GBP), which means that when they do this they are actually putting the foreign exchange rate variation pressure on their customer; not just to pay the price of the goods, but to also then convert the customer’s local currency into GBP when making payment. Put another way, when we invoice in GBP (our own currency), we are actually putting what we call the ‘foreign exchange pressure’ onto our customer, which means that apart from asking our customer to pay a price for our goods, we also burden them to carry any potential risk that may exist in terms of currency conversion, from the customer’s own local currency to our domestic home currency
- Trade in your customer/buyer’s currency. One has to consider here, whether or not there is a competitive advantage in trading in my customer’s currency. Now, in determining the competitive advantage, if there were to be one, I have to look at the currency risk that I would be adopting in actually trading, in what would be a foreign currency to me. This is what we call the ‘foreign currency exchange risk’. That is, where one currency always fluctuates in value against another currency
Now, it is possible that by invoicing in a foreign currency, by the time I get that foreign currency back home, converted into GBP (my home currency), the GBP conversion is resulting in an amount substantially LESS than I expected, and that was because of the fluctuation in the foreign exchange, which could mean I make a loss in my sale (if may profit margins were very tight); naturally, if I’d invoiced in GBP I would have been protected against all this.
On the other hand, if I invoice in the foreign currency and I bring that foreign currency home, and I get more GBP for it then in actual fact I win, because I’m getting more than expected. So there are swings and roundabouts (pros and cons) for trading in your own or foreign currency.
Bottom line: If you don’t want to risk FX rates moving against you then trade in your own home currency; if you wish to make purchasing easy for your customer and are willing to take the FX risk (or have hedged it with an FX Broker) then go with your customer’s foreign currency.
So it’s a double-edged sword.
Yes, there’s a double-edged sword on this one. So again I look at it on the basis of, “Is there a competitive advantage and can I manage this foreign currency risk?” That is number one in this equation. If I can put into place a procedure where I can manage the foreign currency risk then I look at my trading currency advantage. If there is a trading currency advantage and I’m able to manage the foreign currency risk then yes, I will trade in the foreign currency.
Now, there are many options available to exporters in terms of foreign exchange management. Banks offer foreign exchange contracts; fixed rate contracts, and option contracts. Whereby you say to a bank, on a particular date I am going to bring you X number of (say) US dollars, can you tell me today how many Pounds Sterling you will give me for the X amount of US Dollars? The bank will give you a rate there and then, and you ‘lock-in on that fixed rate’. Which means before you even ship the goods, you know exactly what you’ll be able to convert the foreign currency at when you get the cash in.
So that’s lock-in into a forward rate agreement.
Yes, that’s locking into a forward rate agreement, and there are others. There is also what we call currency options, where you pay a premium and you don’t lock yourself into a forward rate agreement, you pay a premium. You take advantage of that type of contract if the foreign currency exchange rate goes against you. If it goes in your favour, you just dismiss it, you’ve already paid your premiums, and you’re not concerned about it.
I know there are many, many businesses that just refuse to step away from the Pound Sterling, and will say “We are only going to trade in Pound Sterling.” But they should realise that they are transferring the foreign exchange risk onto their buyer, and is that something they want to do as they are already under stiff competition.
Remember, you also should be considering what you can manage. It should all be part of the research. What are my competitors doing? Are they trading in their own local currency or are they trading in the customer’s local currency? Now if my competitors are trading in my customer’s local currency then they may be at an advantage, so maybe my price will have to be that 0.00% less than my competitors, because of the advantage that they may have by trading in the local currency. So, these issues all have to be taken on board. Is it important? Yes, getting FX right is a very important factor in international trade.
Again, I have seen companies using this currency issue, massively to their advantage. Using instruments called Bills of Exchange, where they actually allow the foreign buyer to almost be borrowing their money over time at interest rates substantially less than the foreign buyer would be paying to their own bank if they were borrowing it.
So this foreign exchange issue and this currency trading issue is again something the business person, wishing to go into the global market, should take on board, research it, and find out about it. They should learn how does it work, and where they could use it as a competitive advantage. Remember when we talk about these competitive advantages, they’re not an exhaustive list. We always say service is a competitive advantage. So what does that service entail? It entails everything, and foreign exchange is one of them. So, if we think that the service we provide to companies actually contains a potential competitive advantage, then it’s up to us to maximise that competitive advantage and to make sure we’re giving an advantage to our potential buyer on all fronts on the service that we provide in support of our product or service.
OK, I would just add from my humble experience of the FX trading environment many, many years ago that I wouldn’t go to my high street bank to go and get a rate.
I could probably go to them to get a baseline rate and then I’d go, using the leverage of the internet, go on FXcompared.com or Fexco or whatever and be able to see what FX brokers provide because they don’t charge as high a commission as your high street bank would be. One question I guess is one thing a lot of people tend to do is use reserve currencies. Like, the US Dollar is a reserve currency, in many ways. Would you trade in a third currency?
Only if they are readily convertible on the foreign exchange market.
So if you have someone say in Bolivia and we’re in the UK, and they say we can do it but we’re not going to do it in the Bolivian currency (Boliviano), we’re not going to do it in UK currency (GBP), instead we’ll do it in US Dollars, then you’d have just the risk to US Dollars.
Yes, any of these major currencies, the Japanese Yen, the Euro even (if you’re not trading in Euros already), the US Dollar, Australian Dollar, New Zealand Dollar, Canadian Dollar, South African Rand or Chinese Yuan etc. Any of these regular, international, convertible currencies are fine to actually trade in. But again, only on the basis that I’m prepared to research the foreign exchange discipline and procedures. But yes, it is quite common for countries to be trading in currencies that are comfortable for them. Your buyer will in actual fact be selling an awful lot of products to say, the Japanese. Maybe they get paid in Japanese Yen and maybe they’ve got huge reserves of Japanese Yen. So they may offer to pay you in Yen and you think “Oh heck, I can’t do that!” Please! The Yen is a hugely convertible currency. Yes, it fluctuates on the foreign exchange market, like others, and you have to be careful but that’s what we were talking about earlier when we were speaking about these disciplines you put into place.
With the advent of digital and cryptocurrencies recently, one doesn’t need to take a huge leap of faith, from the existing ‘fiat currencies’ or government-backed (some would say manipulated) currencies, to propose international trade use cryptocurrencies as a medium of exchange! Like for instance, BitCoin or Dash etc. Both sides would need to agree, and then they are outside of the banking and governmental systems and can trade in a truly borderless currency.
Hmm… I think we’re a long way away from that presently because the social acceptance of cryptocurrencies hasn’t been as fast as the technologists that founded cryptocurrencies had hoped. Sure there are real parallels between cryptocurrencies and fiat (traditional) currencies in that neither is based on anything physical, however, the traditional currencies are backed by governments, and in the event of a financial crisis (like in 2008) then governments or the IMF will step in. This isn’t something I can say would be true for cryptocurrencies and who would be the lender of last resorts if a financial crisis would to reoccur. Traders would need to consider this.
I hope you enjoyed this. If you’d like more information on international trade, go to www.edgedocs.com