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What Are Currency Effects and Why Are They Eating Tech Companies' Earnings?

What happens when the dollar costs more.

Maksym Darakchi / Shutterstock

If you want to describe how the high value of the U.S. dollar is affecting tech company earnings this quarter, here are some metaphors you can use, free of charge: Headwinds, rough waters, choppy seas, rocky roads.

But what exactly does the strong dollar mean for tech firm revenues?

If you’ve been paying attention to the earnings reports from Apple, Microsoft, Facebook and virtually every major tech firm, “currency effects” are a common refrain for why revenue might not be as strong as it otherwise would be. For example, Tim Cook said that Apple lost $5 billion in revenue because of exchange rate pressures.

The explanation for why a strong dollar is bad for earnings is pretty simple: If you make money internationally, you’re going to lose some value in your sales when you reprice your earnings in dollars. Then again, tech companies don’t say that they have “inflated” profits when the dollar is weak.

But to help make sense of what that actually means for the whole tech ecosystem, Re/code spoke with Dr. Ed Yardeni, the president and chief investment strategist for the firm Yardeni Research. Yardeni has a doctorate in economics from Yale, he was the chief economist for Deutsche Bank in the late 1990s and you might have caught him saying some smart stuff about broader market trends on CNBC.

Noah Kulwin: How do the changing values of currencies affect the earnings numbers of tech companies?

Ed Yardeni: Many tech companies get their revenues and earnings not just in the United States, but also overseas. Some of them export products they make in the U.S., but most of them derive their overseas revenues by selling products that they might even make in those countries — like China — but they don’t make those products in the U.S.

Since tech companies need to report their revenues and earnings in dollars, a strong dollar reduces the dollar value of sales overseas. For example, the trade-weighted dollar (which is one way to measure the currency based on international trade), calculated by J.P. Morgan, is up 22 percent since mid-2015.

If you have a tech company that does half of its business overseas, then a 22 percent appreciation of the dollar over eight months would knock off 11 percent from corporate earnings.

Does this negative impact actually hurt businesses individually, or is just bad for the system as a whole?

In investing, there are two concepts known as alpha and beta. Alpha is events and developments to an individual company in a specific industry. Beta is the overall macroeconomic environment. The cost of borrowing money is something that’s taken for a given, as is a strong dollar. It’s macroeconomic background. And what we’re seeing is that a strong dollar is negative for the bottom line.

How did the dollar get so expensive?

Currencies tend to be among the more mysterious of all the economic variables that economists try to understand. In this case, it’s pretty straightforward. Ever since 2014, it’s become increasingly clear that the Federal Reserve is trying to normalize monetary policy.

By raising interest rates.

Yes. In 2014, once they terminated the quantitative easing program, the chatter started about when they might start raising interest rates. Meanwhile, the other major central banks, like the European Central Bank and the Bank of Japan, are continuing to provide loose monetary policy. And the result is that you have strong dollar. On top of all that you have emerging markets collapsing (Ed. note: He’s talking about China) against the dollar, which is tied to declining commodity prices.

There are expectations for the soaring dollar, but it is a very important economic variable that has tangible impact on revenues and earnings.

Will the strong dollar be a thorn in tech companies’ sides for awhile?

Surprisingly, the Fed doesn’t seem to be as concerned about the strong dollar as I think they should be. Fed officials don’t seem to appreciate the linkage between the dollar and profits. It’s right there in the headlines, I mean you’re writing about it. [The Fed doesn’t] appreciate that it’s bad for profits, and what’s bad for profits is bad for employment and capital and the overall economy. They’ll certainly get the message as companies do respond to weaker profits by cutting back on capital spending and hiring. I think that it’s very unlikely that the Fed will continue to raise interest rates.

That new statement where they said they’re going to raise interest rates? That’s why the stock market took a dive.

This article originally appeared on Recode.net.

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