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Deflation, the dropping dollar, and tech
With the toxic twins now on the horizon, the tech industry may be more resilient than most.
May 21, 2003: 10:36 AM EDT
By Eric Hellweg, CNN/Money Contributing Columnist

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SAN FRANCISCO (CNN/Money) - After an impressive five-week run, the markets took a tumble at the beginning of the week. Currency traders and investors were skittish after Treasury Secretary John Snow signaled a change in the government's "strong dollar" policy, apparently retreating from the longstanding support for a strong dollar in relation to other currencies and embracing instead a dollar that inspires "confidence" and is viewed as "a good medium of exchange."

Also affecting the market were renewed fears of deflation, spurred in part by the 0.3 percent decline in the April consumer price index -- the biggest drop in 19 months.

What do these toxic twins -- the low dollar and deflation -- mean for the tech industry? Are technology's prospects as bad as the market's reaction would have you believe?

The down dollar

Let's start with the shrinking dollar. As with so many things economic, the answer is, "It depends." For our purposes, the answer also depends greatly on what segment of the broad technology industry you're talking about.

Some segments, such as semiconductors, are influenced more by declining currency values, since most of their components are purchased overseas. Other areas, such as services or online retail, wouldn't be hit as hard -- at least not directly -- by a declining dollar.

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And as far as a dollar is concerned, the initial impact for multinational tech companies such as IBM (IBM: Research, Estimates) and Hewlett-Packard (HPQ: Research, Estimates) could well be positive. HP, for example, generates 65 percent of its revenue overseas. Intel (INTC: Research, Estimates) earns 70 percent of its revenue outside the United States. A lower dollar means their goods are more attractive to foreign customers, and that could spur an increase in export sales.

Already these companies have seen some benefit from the newly strong euro: Their European divisions have contributed more to the companies' bottom lines. But if the dollar plummets against the euro too drastically, making European goods too costly, it could stifle sales on the continent and spur a European recession.

Don't forget deflation

Now for deflation. The Fed battled mightily to fend off inflation, but now must deal with the very real possibility that its ugly cousin could make an appearance. Many in the tech industry didn't even want to contemplate the prospect.

"It's the 800-pound gorilla in the room, and no one's talking about it," says Peter Kastner, chief research officer at Aberdeen Group. "Hardware manufacturers have to produce and sell a lot more units at a lower price to keep up on the revenue treadmill. Units are up almost 30 percent at Dell (DELL: Research, Estimates), but revenues were only up 18 percent."

However, deflation shouldn't be all that terrifying for tech. In a sense, the industry is inherently deflationary. "That's what Moore's Law is all about," Kastner says.

Of course, the tech industry's "deflation" is historically driven by innovation, not widespread downward pricing pressure. But the industry, unlike many others, is used to seeing its prices declining at a rapid clip and is prepared for that eventuality. Instead of having to radically alter its business model if deflation hits, the tech industry could simply speed up Moore's Law a notch in its forecasts.

Obviously, deflation is a complicated issue, and thankfully, most analysts I spoke with downplayed the possibility that it would strike the economy at large, but none dismissed it entirely. If deflation were to hit, the tech industry would likely respond first and most adeptly while other sectors, such as real estate, took it on the chin.

As IDC analyst Roger Kay puts it, "It'd be business as usual, only more so."

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